Capital market firms such as EV are hard to value. This is because the rules they face are different to other companies, which can impact the way we forecast their cash flow. For example, capital market businesses are required to hold more capital to reduce the risk to shareholders. Looking at data points such as book values, on top of the return and cost of equity, can be practical for computing EV’s true value. Today I will take you through how to value EV in a relatively effective and easy method. Check out our latest analysis for Eaton Vance

What Model Should You Use?

Let’s keep in mind two things – regulation and type of assets. United States’s financial regulatory environment is relatively strict. Furthermore, capital markets tend to not possess substantial amounts of physical assets as part of total assets. This means the Excess Returns model is best suited for calculating the intrinsic value of EV rather than the traditional discounted cash flow model, which has more emphasis on things like capital expenditure and depreciation.

How Does It Work?

The key belief for this model 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 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)

= (28.77% – 9.00%) * $9.49 = $1.87

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)

= $1.87 / (9.00% – 2.47%) = $28.69

Combining these components gives us EV’s intrinsic value per share:

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

= $9.49 + $28.69 = $38.18

Relative to today’s price of $54.39, EV is priced above its true value. This means EV isn’t an attractive buy right now. Valuation is only one side of the coin when you’re looking to invest, or sell, EV. Fundamental factors are key to determining if EV 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.

2. Future earnings: What does the market think of EV going forward? Our analyst growth expectation chart helps visualize EV’s growth potential over the upcoming years.

3. Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether EV is a dividend Rockstar with our historical and future dividend analysis.

For more details and sources, take a look at our full calculation on EV here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.