Bank stocks such as VLY are hard to value. This is because the rules banks face are different to other companies, which can impact the way we forecast their cash flows. The tiered capital structure is common for banks to abide by, in order to ensure they maintain a sufficient level of cash for their customers. Focusing on elements such as book values, in addition to the return and cost of equity, may be appropriate for assessing VLY’s valuation. Today I will take you through how to value VLY in a fairly accurate and straightforward way. Check out our latest analysis for Valley National Bancorp
What Model Should You Use?
Two main things that set financial stocks apart from the rest are regulation and asset composition. United States’s financial regulatory environment is relatively strict. In addition, banks generally don’t have substantial portions of physical assets as part of total assets. So the Excess Returns model is suitable for determining the intrinsic value of VLY rather than the traditional discounted cash flow model, which places emphasis on factors such as depreciation and capex.
The Calculation
The central assumption 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 above the cost of equity is known as excess returns:
Excess Return Per Share = (Stable Return On Equity – Cost Of Equity) (Book Value Of Equity Per Share)
= (11.11% – 9.77%) * $9.6 = $0.13
We use this value to calculate the terminal value of the company, which is how much we expect the company to continue to earn every year, forever. This is a common component of discounted cash flow models:
Terminal Value Per Share = Excess Return Per Share / (Cost of Equity – Expected Growth Rate)
= $0.13 / (9.77% – 2.47%) = $1.77
Combining these components gives us VLY’s intrinsic value per share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $9.6 + $1.77 = $11.37
Compared to the current share price of $12.14, VLY is , at this time, priced in-line with its intrinsic value. This means there’s no real upside in buying VLY at its current price. Valuation is only one part of your investment analysis for whether to buy or sell VLY. Analyzing fundamental factors are equally important when it comes to determining if VLY has a place in your holdings.
Next Steps:
For banks, there are three key aspects you should look at:
1. Financial health: Does it have a healthy balance sheet? Take a look at our free bank analysis with six simple checks on things like bad loans and customer deposits.