Banking Pool

Calculating Intrinsic Value for Bank Stocks

Intrinsic Value of 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 reasoning 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. These certain business attributes are unusual and therefore demand modification to any 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. A bank’s asset side of the balance sheet is customarily more than 85% weighted with loans and other earning assets. Therefore, the respective intrinsic value formulas must take this into consideration. Finally, banks and other financial institutions are susceptible to net interest margins which is tied to the portfolio’s risk factors (types of loans) and the sourcing of capital to finance these earning assets. Thus, the formula for intrinsic value must adapt to this interest spread between what is earned and what is paid out for use of money.

This article goes into great detail about how banks make a profit. The intrinsic value formula is designed around this unique business model. The final section goes through an eight step procedure to determine intrinsic value of bank stock. This article is for members only of this site’s Value Investment Club. It uses Wells Fargo as its sample and sets Wells Fargo’s intrinsic value point as of February 2021. For those of you desiring to read the entire article, you must join as a member; click on the Value Investing tab above and select Membership to read about the program and join the Club.

Purchased Bank of New York Mellon Corporation

Bank of New York

The banking pool of the Value Investment Fund purchased 232.9373 shares of Bank of New York Mellon Corporation trading at $41.93 at close of business on Friday January 22, 2021. Total investment is $10,000 for 232.9373 shares at $42.93 including a $1 per share exchange fee.

After careful analysis, it was determined that the bank’s stock price is selling at or below intrinsic value. Furthermore, a reasonable market recovery share price is determined to be $52 per share and that this price will come to bear sometime during 2021. The underlying reasoning is as follows.

Purchased 2nd Tranche of Wells Fargo Bank

Wells Fargo Bank

The Value Investment Fund purchased a second tranche of Wells Fargo Bank shares today, January 14, 2021, at 12:45 PM. Total investment is $20,000. The price per share including a $1 per share transaction fee is $35.78.

This particular investment is a part of the Banking Pool for the Club’s Investment Fund. The stock is currently trading just slightly higher than the traditional book value for Wells Fargo. The preset sell price is $53 per share.

Sold Comerica Bank – Earned 18.38% in 35 Days!

Comerica Bank

Today, Comerica’s stock price hit the sell point in accordance with the buy/sell model for Comerica Bank. At the market’s opening this morning, January 14, 2021, the stock quickly jumped past $65 per share. The order to sell is set at $65 per share. Total proceeds net of $1 per share transaction fees was $23,677.40. The cost basis including a $1 per share transaction fee from December 11, 2020 was $20,000. Therefore, the gain on the sale equals $3,677.40. Time of holding was 35 days; thus, the return on the investment is a whopping 18.38%.

Purchased 292.0560 Shares Wells Fargo Bank

Wells Fargo

With a tangible book value of approximately $33 per share and a current market price of $33.24 per share, the Banking Pool diversified its portfolio and purchased 292.056 shares of Wells Fargo Bank this morning. The company is due to report its quarter results later this week. 

Including a transaction fee of $1 per share, the total investment is $10,000. The market recovery price is set to $53.00 per share and it is anticipated this will be achieved within 18 months.

Value Investment Fund Buys 369.9593 Shares of Comerica Bank

Comerica Bank

The value investment fund’s banking pool includes Comerica Bank. Based on the investment’s buy/sell model, this morning prior to opening, an order for 369.9593 shares at $53.06 was entered. Including the cost of $1.00 per share, total investment is $20,000. The preset sell price is now set at $65.00. Based on historical information, it is believed that this target price can be achieved by the end of February 2021.