Pricing bank stocks such as NSM 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.
These lenders, for example, must hold certain levels of capital in order to maintain a safe cash cushion.
in addition to
the return and cost of equity,
I’ll take you through
how to value NSM in a
See our latest analysis for Nationstar Mortgage Holdings
What Model Should You Use?
Financial firms differ to other sector firms primarily because of the kind of regulation they face and their asset composition.
United States’s financial regulatory environment is relatively strict.
mortgage and thrift companies
usually do not
of tangible assets
on their books.
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.
Calculating NSM’s Value
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)
= (10.59% – 9.62%) * $22.84 = $0.22
Excess Return Per Share is used to calculate the terminal value of NSM, 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)
= $0.22 / (9.62% – 2.95%) = $3.34
These factors are combined to calculate the true value of NSM’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $22.84 + $3.34 = $26.18
This results in an intrinsic value of $26.18.
Given NSM’s current share price of
US$17.76, NSM is
, at this time,
trading below what it’s actually worth.
Therefore, there is potential room to profit from mispricing if you bought NSM at $26.18.
Pricing is only one aspect when you’re looking at whether to buy or sell NSM.
There are other important factors to keep in mind when assessing whether NSM is the right investment in your portfolio.
For mortgage and thrift companies, there are three key aspects you should look at:
- 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.
- Future earnings: What does the market think of NSM going forward? Our analyst growth expectation chart helps visualize NSM’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether NSM is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on NSM here.
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