Great-West Lifeco (TSE: GWO) is one of the three big Canadian life insurance firms. With just under half of the firm’s profit and revenue in Canada, Great-West also operates in the U.S. and Europe.
GWO’s share price is down roughly 13.5% year-to-date and down approximately 8.2% in the past year (not including dividends). Nevertheless, it may be undervalued at the moment.
Valuing Great-West Lifeco
To value GWO, I will use the excess returns model. This approach is more appropriate for financial companies because they tend to have volatile free cash flows. As a result, trying to create forecasts for them is futile. The excess returns model allows us to use historical numbers instead, which are actual results. There are a few steps to follow for this valuation method.
First, you calculate a company’s excess returns. Next, you calculate the terminal value. Add them up, and you get your valuation. Here’s how it works:
Excess Returns = (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
I will use the following assumptions for my calculations:
Average ROE: 12.9% (five-year average)
Cost of Equity: 8.9% (value taken from Finbox)
Book Value: C$26.18
Growth Rate: 3.4% (using the 30-year Government of Canada yield as a proxy for long-term growth expectations)
Now that I have my assumptions, let’s plug them into the formulas:
C$1.05 = (0.129 – 0.089) x C$26.18
C$19.09 = C$1.05 / (0.089 – 0.034)
C$45.27 = C$26.18 + C$19.09
As a result, I estimate that Great-West Lifeco is currently worth C$45.27 per share under current market conditions.
Dividend
For income-oriented investors, GWO pays a 6.06% dividend yield on an annualized basis. When taking a look at GWO’s historical dividend yield, you can see that it has remained relatively flat:
At 6.06%, the current yield is near the middle of the range, indicating that income-oriented investors are paying a fair price relative to yields they have been able to receive in the past.
Analyst Recommendations
Great-West Lifeco has a Hold consensus rating based on six Holds and one Sell assigned in the past three months. The average Great-West Lifeco price target of C$39.17 implies 24% upside potential.
Final Thoughts
GWO is a reliable company that may be trading at a discount based on analyst estimates and the excess returns valuation model. As a result, investors may want to consider GWO stock for their portfolios.