Bank of Nova Scotia (TSE: BNS) (BNS) provides financial products and services, including personal, commercial, corporate, and investment banking. It operates through the following segments: Canadian Banking, International Banking, Global Banking and Markets, and Global Wealth Management.
BNS recently reported earnings, which beat expectations. Earnings per share came in at C$2.18, above analysts’ expectations of C$1.97. Revenue was C$7.94 billion, which also beat the consensus by C$70 million.
BNS’ share price is down roughly 4.8% year-to-date but up approximately 9.5% in the past year. Nevertheless, it may be undervalued at the moment despite bouncing after a rather large sell-off.
Is the Bank of Nova Scotia Undervalued?
To value Bank of Nova Scotia, 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 is ineffective. 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 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 ROE: 13.0% (five-year average)
Cost of Equity: 7.8%
Book Value: C$58.60
Growth Rate: 2.89% (used 30-year Government of Canada bond yield as a proxy for long-term growth expectations)
Now that I have my assumptions, I’ll plug them into the formulas, which are in Canadian Dollars:
$3.047 = (0.13 – 0.078) x $58.60
$62.06 = $3.047 / (0.078 – 0.0289)
$120.66 = $58.60 + $62.06
As a result, the Bank of Nova Scotia is currently worth C$120.66 per share under current market conditions.
BNS Has a Solid Dividend
For income-oriented investors, BNS pays a 4.8% dividend yield on an annualized basis. When taking a look at Bank of Nova Scotia’s historical dividend yield, you can see that it has been volatile:
At 4.8%, the current yield is on the low end of the range, indicating that income-oriented investors are paying a slight premium relative to yields they have been able to receive in the past.
Bank of Nova Scotia has a Moderate Buy consensus rating based on seven Buys, six Holds, and zero Sells assigned in the past three months. The average Bank of Nova Scotia price target of C$92.38 implies 7.8% upside potential.
BNS had a solid quarter, beating analysts’ expectations, similar to the results of its peer Toronto-Dominion Bank (TD). Analysts only expect single-digit upside potential. However, the excess returns model implies that BNS stock may be worth more than what the market thinks.
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