Calculating Intrinsic Value for Bank Stocks
Financial institutions, including banks, are highly regulated, extremely leveraged, and susceptible to interest rate fluctuations. Due to this unique exposure, calculating intrinsic value for bank stocks requires modification of the most popular valuation models. There are about five widely accepted intrinsic valuation models used with determining the core price for stock of most companies. Novice or lazy investors rely heavily on these so-called textbook models to calculate intrinsic value as the baseline for buying stock. Sophisticated investors will modify popular models to create a customized formula for each respective industry. It requires some rational thinking and reasonable assumptions to design and implement a model for any industry. This article goes into detail about designing and executing an intrinsic valuation model for banks.
To cover the thought process of creating this banking model, it is first explained how banks are in their own corner of the business world. Certain business attributes of banking are unusual and therefore demand modification to the intrinsic calculation model. Secondly, compliance regulation further complicates calculating value. In some situations, the government penalizes banks by restricting their ability to conduct business which then impacts earnings. Since most valuation models are oriented around earnings, compliance in banking demands changes to the intrinsic formula. A third dynamic with banks is the leverage issue. Most stock price valuation models assume the respective company is at least mildly leveraged. Banks are not not mildly leveraged in comparison to other industries; they are extremely leveraged. Therefore,
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