Valuing RSA, an insurance stock, can be daunting since these financial firms generally have cash flows that are impacted by regulations that are not imposed upon other industries. Industry-specific factors, such as gross written premiums are crucial in understanding how insurance companies make money. Looking at factors such as book values, on top of the return and cost of equity, is practical for calculating RSA’s true value. Today I’ll determine how to value RSA in a reasonably useful and simple approach.
View our latest analysis for RSA Insurance Group
What Model Should You Use?
Financial firms differ to other sector firms primarily because of the kind of regulation they face and their asset composition. United Kingdom’s financial regulatory environment is relatively strict. Furthermore, insurance companies usually do not possess large portions of tangible assets on their balance sheet. So the Excess Returns model is suitable for determining the intrinsic value of RSA rather than the traditional discounted cash flow model, which places emphasis on factors such as depreciation and capex.
How Does It Work?
The central belief for Excess Returns is, the value of the company is how much money it can generate from its current level of equity capital, in excess of the cost of that capital. The returns in excess of cost of equity is called excess returns:
Excess Return Per Share = (Stable Return On Equity – Cost Of Equity) (Book Value Of Equity Per Share)
= (0.15% – 8.3%) x £4.05 = £0.26
Excess Return Per Share is used to calculate the terminal value of RSA, which is how much the business is expected to continue to generate over the upcoming years, in perpetuity. This is a common component of discounted cash flow models:
Terminal Value Per Share = Excess Return Per Share / (Cost of Equity – Expected Growth Rate)
= £0.26 / (8.3% – 1.4%) = £3.82
Combining these components gives us RSA’s intrinsic value per share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= £4.05 + £3.82 = £7.87
This results in an intrinsic value of £7.87. Given RSA’s current share price of UK£5.75, RSA is , at this time, undervalued. Therefore, there is potential room to profit from mispricing if you bought RSA at £7.87. Pricing is one part of the analysis of your potential investment in RSA. Fundamental factors are key to determining if RSA fits with the rest of your portfolio holdings.
Next Steps:
For insurance companies, there are three key aspects you should look at:
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Financial health: Does it have a healthy balance sheet? Take a look at our free bank analysis with six simple checks on things like leverage and risk.
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Future earnings: What does the market think of RSA going forward? Our analyst growth expectation chart helps visualize RSA’s growth potential over the upcoming years.
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Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether RSA is a dividend Rockstar with our historical and future dividend analysis.