iA Financial (TSE: IAG) is a life and health insurance company. It offers life and health insurance products, savings and retirement plans, mutual funds, securities, auto and home insurance, mortgages, and more.
IAG’s share price is down roughly 14.5% year-to-date and down approximately 5.9% in the past year (not including dividends). Nevertheless, it may be undervalued at the moment despite rebounding from its May lows.
To value iA Financial, 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 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
I will use the following assumptions for our calculations:
Average ROE: 12.0% (five-year average)
Cost of Equity: 9.2% (value taken from Finbox)
Book Value: C$61.43
Growth Rate: 3.25% (used 30-year U.S. Treasury yield as a proxy for long-term growth expectations)
Now that we have our assumptions, let’s plug them into the formulas:
C$1.72 = (0.12 – 0.092) x C$61.43
C$28.91 = C$1.72 / (0.092 – 0.0325)
C$90.34 = C$61.43 + C$28.91
As a result, iA Financial is currently worth C$90.34 per share under current market conditions. With a stock price of C$60.90, this leaves plenty of upside potential.
For income-oriented investors, IAG pays a 4.02% dividend yield on an annualized basis. When taking a look at IAG’s historical dividend yield, you can see that it has remained relatively flat:
At 4.02%, the current yield is on the high end of the range, indicating that income-oriented investors are paying a discount relative to yields they have been able to receive in the past.
iA Financial has a Strong Buy consensus rating based on six Buys and one Hold assigned in the past three months. The average iA Financial price target of C$83.29 implies 36.8% upside potential.
IAG is a solid company and appears to be trading at a discount, as both analyst estimates and the excess returns valuation model suggest upside potential. As a result, investors may want to consider IAG for their portfolios.