Pricing capital market stocks such as 6881 is particularly challenging. Given that these companies adhere to a different set of rules relative to other companies, their cash flows should also be valued differently. For example, capital market businesses are required to hold more capital to reduce the risk to shareholders. Emphasizing elements like book values, as well as the return and cost of equity, may be useful for determining 6881’s valuation. Below I’ll take you through how to value 6881 in a fairly effective and simple approach. Check out our latest analysis for China Galaxycurities

What Model Should You Use?

Two main things that set financial stocks apart from the rest are regulation and asset composition. Strict regulatory environment in China’s finance industry reduces 6881’s financial flexibility. In addition, capital markets generally don’t possess substantial amounts of tangible assets on their books. So the Excess Returns model is suitable for determining the intrinsic value of 6881 rather than the traditional discounted cash flow model, which places emphasis on factors such as depreciation and capex.

Deriving 6881’s Intrinsic Value

The key belief for Excess Returns is that equity value is how much the firm can earn, over and above its cost of equity, given the level of equity it has in the company at the moment. 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)

= (9.15% – 11.45%) * CN¥6.18 = CN¥-0.16

Excess Return Per Share is used to calculate the terminal value of 6881, 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)

= CN¥-0.16 / (11.45% – 1.88%) = CN¥-1.67

These factors are combined to calculate the true value of 6881’s stock:

Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share

= CN¥6.18 + CN¥-1.67 = HK$6.22

Relative to today’s price of CN¥5.62, 6881 is currently fairly priced by the market. This means 6881 isn’t an attractive buy right now. Pricing is only one aspect when you’re looking at whether to buy or sell 6881. Fundamental factors are key to determining if 6881 fits with the rest of your portfolio holdings.

Next Steps:

For capital markets, 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 leverage and risk.