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Valuing SPGI, a financial stock, can be daunting since these capital market firms generally have cash flows that are impacted by regulations that are not imposed upon other industries. Asset managers, for example, must hold certain levels of capital in order to maintain a safe cash cushion. Emphasizing line items such as book values, as well as the return and cost of equity, may be suitable for assessing SPGI’s value. Below I will show you how to value SPGI in a fairly effective and simple way. Check out our latest analysis for S&P Global
What Is The Excess Return Model?
Financial firms differ to other sector firms primarily because of the kind of regulation they face and their asset composition. SPGI operates in United States which has stringent financial regulations. Moreover, capital markets tend to not have significant portions of physical assets on their balance sheet. While traditional DCF models emphasize on inputs such as capital expenditure and depreciation, which is less useful for a financial stock, the Excess Return model focuses on book values and stable earnings.
How Does It Work?
The key belief for this model 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 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)
= (273.24% – 8.77%) * $4.85 = $12.83
Excess Return Per Share is used to calculate the terminal value of SPGI, 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)
= $12.83 / (8.77% – 2.47%) = $203.52
Combining these components gives us SPGI’s intrinsic value per share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $4.85 + $203.52 = $208.37
Given SPGI’s current share price of $194.83, SPGI is priced in-line with its intrinsic value. Therefore, there’s a bit of a downside if you were to buy SPGI today. Valuation is only one side of the coin when you’re looking to invest, or sell, SPGI. Analyzing fundamental factors are equally important when it comes to determining if SPGI has a place in your holdings.
Next Steps:
For capital markets, 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 SPGI going forward? Our analyst growth expectation chart helps visualize SPGI’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 SPGI is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on SPGI 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.