Yahoo Finance Intrinsic Calculation For Insurance Australia Group Limited (ASX:IAG) Shows Investors Are Overpaying
Valuing IAG, an insurance stock, can be daunting since these financial firms generally have cash flows that are impacted by regulations that are not imposed upon other industries. For example, insurance companies are required to hold more capital to reduce the risk to shareholders. Examining elements such as book values, on top of the return and cost of equity, may be appropriate for evaluating IAG’s value. Below we will look at how to value IAG in a reasonably effective and easy method.
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Why Excess Return Model?
Financial firms differ to other sector firms primarily because of the kind of regulation they face and their asset composition. Financial firms operating in Australia face strict financial regulation. In addition, insurance companies tend to not hold large portions of tangible assets as part of total assets. 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.
Deriving IAG’s Intrinsic Value
The main 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)
= (0.16% – 8.5%) x A$2.88 = A$0.21
Excess Return Per Share is used to calculate the terminal value of IAG, 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)
= A$0.21 / (8.5% – 2.3%) = A$3.41
Putting this all together, we get the value of IAG’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= A$2.88 + A$3.41 = A$6.29
This results in an intrinsic value of A$6.29. Compared to the current share price of AU$7.03, IAG is , at this time, trading in-line with its true value. Therefore, there’s a bit of a downside if you were to buy IAG today. Pricing is only one aspect when you’re looking at whether to buy or sell IAG. Fundamental factors are key to determining if IAG fits with the rest of your portfolio holdings.
Next Steps:
For insurance 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 leverage and risk.
Future earnings: What does the market think of IAG going forward? Our analyst growth expectation chart helps visualize IAG’s growth potential over the upcoming years.
Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether IAG is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on IAG here.
To help readers see past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
