Pricing consumer finance stocks such as SHRIRAMCIT 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. For example, businesses that deal with loans are required to hold more capital to reduce the risk to shareholders. Emphasizing elements such as book values, in addition to the return and cost of equity, is beneficial for assessing SHRIRAMCIT’s intrinsic value. Today I’ll take you through how to value SHRIRAMCIT in a fairly effective and straightforward way.
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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. India’s financial regulatory environment is relatively strict. Moreover, consumer financials usually do not possess significant portions of physical assets as part of total assets. The Excess Returns model overcomes the required capital kept on hand and lack of tangibles by focusing on forecasting stable earnings, rather than less relevant factors such as depreciation and capex, which more traditional models focus on.
Deriving SHRIRAMCIT’s Intrinsic Value
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 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)
= (16.69% – 13.5%) x ₹1109.34 = ₹34.91
Excess Return Per Share is used to calculate the terminal value of SHRIRAMCIT, 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)
= ₹34.91 / (13.5% – 7.7%) = ₹600.2
Putting this all together, we get the value of SHRIRAMCIT’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= ₹1109.34 + ₹600.2 = ₹1709.53
This results in an intrinsic value of ₹1721.43. Given SHRIRAMCIT’s current share price of ₹1,895, SHRIRAMCIT is , at this time, trading in-line with its true value. This means SHRIRAMCIT isn’t an attractive buy right now. Valuation is only one part of your investment analysis for whether to buy or sell SHRIRAMCIT. There are other important factors to keep in mind when assessing whether SHRIRAMCIT is the right investment in your portfolio.