Sun Life Financial (TSE: SLF) (NYSE: SLF) is a Canadian financial services company and one of the world’s largest insurers. It also has a ‘Perfect 10’ Smart Score, implying that it can outperform the market, going forward. SLF has outperformed the U.S. market over multiple time frames when including dividends. Below is a year-to-date performance chart, with its performance against the S&P 500 (SPX) measured in U.S. dollars. It has even beaten the TSX index when measured in Canadian dollars. Despite its perfect Smart Score and solid track record, the stock’s valuation doesn’t leave a high amount of upside potential. Therefore, we are neutral on the stock for now.
Is SLF a High-Quality Stock?
Sun Life is a high-quality stock. About three months ago, we wrote an SLF stock analysis article that talked about its positives, which include steadily growing earnings-per-share (EPS) and book-value-per-share figures. Also, its dividend, which yields 4.57%, has grown consistently (at a 10-year CAGR of 6.7%), and its five-year average return on equity of 12.1% is considered good.
While its long-term growth regarding book value, earnings, and dividends can provide solid returns for investors, these returns may not be anything too substantial. When we wrote our last SLF article, the stock was trading near C$57. Now, it is trading above C$63, giving it less upside potential. Let’s discuss its valuation below.
Sun Life Stock May be Slightly Overvalued
To value Sun Life stock, we will use the excess returns model, which is more appropriate for financial companies because they tend to have volatile free cash flows.
As a result, trying to create forecasts for them doesn’t work well. The excess returns model allows us to use historical numbers instead, which are tangible. There are a few steps to follow for this valuation method.
First, you calculate a company’s excess return, meaning the spread between its return on equity (ROE) and its cost of equity; a higher ROE than the cost of equity is a good thing. Next, you calculate its terminal value. Add them up, and you get your valuation. Here’s the formula:
- Excess Return = (Average ROE – Cost of Equity) x Book Value Per Share
- Terminal Value = Excess Return / (Cost of Equity – Growth Rate)
- Fair Value = Book Value Per Share + Terminal Value
We will use the following assumptions for our calculations:
Average return on equity (ROE): 12.1% (five-year average)
Cost of equity: 9.8%
Book value per share: C$45.18
Growth rate: 3.17% (used 30-year Government of Canada bond yield as a proxy for long-term growth expectations)
Now that we have our assumptions, we’ll plug them into the formula highlighted above. The figures are in Canadian dollars:
- $1.039 = (0.121 – 0.098) x $45.18
- $15.67 = $1.039 / (0.098 – 0.0317)
- $60.85 = $45.18 + $15.67
Therefore, SLF stock is currently worth C$60.85 per this valuation method. Its current share price is near C$63, making it slightly overvalued.
Is SLF Stock a Buy, According to Analysts?
SLF stock earns a Moderate Buy consensus rating based on five Buys and three Hold ratings assigned in the past three months. The average SLF stock forecast of C$66.84 implies 5.9% upside potential.
Takeaway: SLF Stock is Sending Mixed Signals
To recap, Sun Life Financial is an excellent company that has the potential to generate solid returns from here, and its Smart Score suggests the same. However, it’s likely a better idea to wait for a pullback, as its valuation has room to come down. Also, analysts only forecast 5.9% upside potential for the next year, which is nothing to get excited about. Therefore, we are neutral.
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