Is The Royal Bank of Scotland Group plc (LON:RBS) Expensive For A Reason? A Look At The Intrinsic Value

Bank stocks such as RBS are hard to value. This is because the rules banks face are different to other companies, which can impact the way we forecast their cash flows. The tiered capital structure is common for banks to abide by, in order to ensure they maintain a sufficient level of cash for their customers. Emphasizing line items like book values, on top of the return and cost of equity, may be suitable for assessing RBS’s true value. Below I’ll take you through how to value RBS in a relatively accurate and straightforward method. Check out our latest analysis for Royal Bank of Scotland Group

Why Excess Return Model?

Before we begin, remember that financial stocks differ in terms of regulation and balance sheet composition. The regulatory environment in United Kingdom is fairly rigorous. Moreover, banks usually do not hold substantial amounts of tangible assets as part of total assets. Therefore the Excess Returns model is appropriate for deriving the true value of RBS as opposed to the traditional model, which puts weight on factors such as capital expenditure and depreciation.

LSE:RBS Intrinsic Value Jun 8th 18

Calculating RBS’s Value

The central belief for this model 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)

= (6.72% – 8.69%) * £3.38 = £-0.07

We use this value to calculate the terminal value of the company, which is how much we expect the company to continue to earn every year, forever. This is a common component of discounted cash flow models:

Terminal Value Per Share = Excess Return Per Share / (Cost of Equity – Expected Growth Rate)

= £-0.07 / (8.69% – 1.40%) = £-0.91

Combining these components gives us RBS’s intrinsic value per share:

Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share

= £3.38 + £-0.91 = £2.47

Relative to the present share price of £2.71, RBS is fairly priced by the market. This means RBS isn’t an attractive buy right now. Valuation is only one part of your investment analysis for whether to buy or sell RBS. Fundamental factors are key to determining if RBS fits with the rest of your portfolio holdings.

Next Steps:

For banks, there are three key aspects you should look at:

1. 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.

2. Future earnings: What does the market think of RBS going forward? Our analyst growth expectation chart helps visualize RBS’s growth potential over the upcoming years.

3. Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether RBS is a dividend Rockstar with our historical and future dividend analysis.

For more details and sources, take a look at our full calculation on RBS here.
To help readers see pass 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.