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Bank stocks such as BARC 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. For instance, banks must hold a certain level of cash reserves on the books as a safety precaution. Focusing on data points such as book values, as well as the return and cost of equity, is beneficial for assessing BARC’s intrinsic value. Today I’ll take you through how to value BARC in a reasonably useful and simple way. Check out our latest analysis for Barclays
What Is The Excess Return Model?
There are two facets to consider: regulation and type of assets. The regulatory environment in United Kingdom is fairly rigorous. In addition, banks generally don’t possess large amounts of physical assets as part of total assets. So the Excess Returns model is suitable for determining the intrinsic value of BARC rather than the traditional discounted cash flow model, which places emphasis on factors such as depreciation and capex.
Deriving BARC’s True 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)
= (6.72% – 8.48%) * £3.25 = £-0.06
Excess Return Per Share is used to calculate the terminal value of BARC, 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)
= £-0.06 / (8.48% – 1.49%) = £-0.82
These factors are combined to calculate the true value of BARC’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= £3.25 + £-0.82 = £2.43
Relative to the present share price of £2.06, BARC is currently fairly priced by the market. This means BARC isn’t an attractive buy right now. Pricing is one part of the analysis of your potential investment in BARC. There are other important factors to keep in mind when assessing whether BARC is the right investment in your portfolio.
Next Steps:
For banks, 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 bad loans and customer deposits.
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Future earnings: What does the market think of BARC going forward? Our analyst growth expectation chart helps visualize BARC’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 BARC is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on BARC 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.