In This Article:
Pricing insurance stocks such as MPL 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. Industry-specific factors, such as gross written premiums are crucial in understanding how insurance companies make money. Focusing on elements such as book values, in addition to the return and cost of equity, may be appropriate for gauging MPL’s true value. Below we will look at how to value MPL in a relatively accurate and easy approach. Check out our latest analysis for Medibank Private
What Model Should You Use?
Two main things that set financial stocks apart from the rest are regulation and asset composition. Australia’s financial regulatory environment is relatively strict. Moreover, insurance companies usually do not hold significant portions of physical assets on their books. Excess Returns overcome some of these issues. Firstly, it doesn’t focus on factors such as capex and depreciation – relevant for tangible asset firms – but rather emphasize forecasting stable earnings and book values.
The Calculation
The key belief 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 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)
= (24.47% – 8.55%) * A$0.68 = A$0.11
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)
= A$0.11 / (8.55% – 2.76%) = A$1.87
Combining these components gives us MPL’s intrinsic value per share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= A$0.68 + A$1.87 = A$2.55
Given MPL’s current share price of A$2.9, MPL is , at this time, fairly priced by the market. Therefore, there’s a bit of a downside if you were to buy MPL today. Valuation is only one side of the coin when you’re looking to invest, or sell, MPL. Fundamental factors are key to determining if MPL fits with the rest of your portfolio holdings.
Next Steps:
For insurance companies, 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 leverage and risk.
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Future earnings: What does the market think of MPL going forward? Our analyst growth expectation chart helps visualize MPL’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 MPL is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on MPL 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.