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EDELWEISS operates in the capital markets sector, which has characteristics that make it unique to other industries. Understanding these differences is crucial when it comes to putting a value on the financial stock. For example, capital market businesses are required to hold more capital to reduce the risk to shareholders. Examining line items such as book values, with the return and cost of equity, is practical for calculating EDELWEISS’s value. Today I’ll determine how to value EDELWEISS in a relatively effective and uncomplicated approach.
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Why Excess Return Model?
Two main things that set financial stocks apart from the rest are regulation and asset composition. The regulatory environment in India is fairly rigorous. Moreover, capital markets tend to not hold significant amounts of physical assets on their books. Therefore the Excess Returns model is appropriate for deriving the true value of EDELWEISS as opposed to the traditional model, which puts weight on factors such as capital expenditure and depreciation.
Deriving EDELWEISS’s Intrinsic Value
The main assumption 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 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)
= (0.17% – 15%) x ₹99.26 = ₹2.51
Excess Return Per Share is used to calculate the terminal value of EDELWEISS, 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)
= ₹2.51 / (15% – 7.7%) = ₹36.79
Combining these components gives us EDELWEISS’s intrinsic value per share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= ₹99.26 + ₹36.79 = ₹136.04
This results in an intrinsic value of ₹136.04. Relative to today’s price of ₹141, EDELWEISS is priced in-line with its intrinsic value. Therefore, there’s a bit of a downside if you were to buy EDELWEISS today. Valuation is only one side of the coin when you’re looking to invest, or sell, EDELWEISS. Analyzing fundamental factors are equally important when it comes to determining if EDELWEISS has a place in your holdings.
Next Steps:
For capital markets, there are three key aspects you should look at: