Assignment 4 Week 8 - Grade: A PDF

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Financial Institution Analysis...

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Introduction SunTrust Banks, Inc. (STI) is a large financial institution headquartered in Atlanta, GA. Incorporated in 1984, the company has both business and personal banking clients. The bank’s locations spread throughout the US East Coast (From Florida to Maryland) as well as Tennessee. The 10-k report for YE 2017 reports the company had assets of $206B with total deposits of $161B (STI 10-K). The purpose of this technical analysis and valuation is to evaluate how well STI performs, not only compared to industry standards, but in comparison to its competitors. The data used for this analysis was obtained through a review of credible sources including Yahoo! Finance, Finviz.com and the company’s 2017 10-K report, filed with the SEC. Models for valuation have been obtained from Aswath Damodoran’s book, Investment Valuation, 3rd ed, John Wiley & Sons (2012). Analysis This analysis will focus on three useful tools for valuation and include a Dividend Discount Model (DDM), Valuation by Comparables and an Excess Returns Model Evaluation. The DDM is useful to determine if a company’s stock is properly valued. Analysts use this method to asses whether the stock is properly valued by using a regression formula to trace future dividends to current value. In calculating future dividend growth, the discount model’s stock value is determined and provides insight as to if a stock is currently over or undervalued. Simply put, If the DDM returns a stock value lower that the current share price, the asset is undervalued. Should the DDM present a stock value higher than the current share price, we can assume the stock is currently overvalued. This information can prove particularly useful to

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investors who wish to know whether they should buy or sell shares, now, or at least ease uncertainties about their decisions pertaining to the stock, in the foreseeable future. Valuation by Comparables, or Relative Valuation, will examine key stock financial ratios, known as multiples, to compare STI to its competitors’ comparable assets. Considering that no two companies, or even assets, are perfectly identical-this type of analysis requires an elevated working knowledge of STI and its operations/assets, as well as knowledge of competitors and comparable structure and assets. Analysts must take precaution to limit biases and recognize that relative valuation is market-sensitive, as it reflects the performance of the current market (Damodoran, 2012). The Excess Returns Model Valuation will serve as a backup confirmation of the findings in the DDM. It is calculated using the principle that the company’s value can be confirmed by calculating the sum of present equity investments and the value of expected investors’ returns (Damodoran, 2012). For the purpose of this analysis, calculations will be made using data reported on STI’s 2017 financials. Discount Dividend Model (DDM) and Principle Assumptions Since dividends have been relatively stable and continue to show signs of growth, the Gordon Growth model is used, assuming terminal value in Y5. In this calculation, the growth rate is used to determine the intrinsic value of STI stock by concept that the stock is supposed to be worth its future dividends that have been discounted to present value. The growth rate for 2017 was calculated by using the formula (2017 Earnings/2013 earnings) ^1/5 – 1. Using values=($228.2M/$193.1M) ^.2 – 1, which yields a growth rate of 3.4%, after rounding. Yahoo! Finance and the company’s 2017 10-K report provide the data used in this method.

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Figure D.1: DDM Spreadsheet

The Constant Growth Model assumes that growth rates remain constant while the variable growth rate contends that said rates are subject to change, at any time. The stock values for these two models are $44.56 and $45.59, respectively. According to Yahoo Finance, current stock price is $52.18 per share. These valuation models both present a close number to the current price, as the variance is less than $7. The biggest concern with this type of valuation seems to be that the analysis measures expected returns on dividend yields, but perhaps not the true expected returns of the actual investors (Cochrane, 2017).

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Valuation by Comparables In comparing STI to competing firms, bias was mitigated by choosing domestic financial institutions with a similar structure. Ratios used in relative valuation help to conclude STI’s position in the market, not just its position in terms of shareholder equity and earnings. Wells Fargo, JP Morgan Chase, US Bank and Citigroup will serve as anchors for this analysis. Yahoo!Finance and finviz.com provide the date used in this analysis.

Figure C.1 : Valuation by Comparables Chart

As referenced in figure C.1, STI has significantly less income than its competitors. However, the company with similar income, Wells Fargo, has similar ratios to those of STI. EV/Sales: calculated as Enterprise value / Net sales This ratio is a measure of company value in relation to its sales. We see that STI generates $1.41 of EV per $1 in sales. This is a look at how much it will cost investors to buy the company’s sales. JPM and C both have a negative number. This means that the company has more cash than debt and can essentially buy itself. Though USB has more than double the sales of STI, its ratio

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produced a result of 7.81. This is more than double the ratio for WFC and more than 5x the ratio for STI. Price / Sales: calculated as Share price / Sales per share This measures the investors’ value in the stock as it computes how much investors are paying per dollar of a company’s stock. STI has a P/S ratio in the middle range of values obtained from this group. Peers in the groups have similar values, with not much variation between them. However, both USB and WFC have ratios above 3. We know that the higher the ratio, the higher the company is valued. A shortcoming of this ratio is that debt is not included in the valuation formula. Though one company may appear more valuable based on this measure, alone, it is prudent to evaluate other aspects of the business to understand if the amount of debt would pose a problem, in the future. EV/EBIT: calculated as Enterprise value / EBITD Being able to understand a company’s value-per-dollar, based on EBIT, can be useful when deciding if a company is properly valued. In this example, STI is overvalued at 3.29. JPM and C have negative figures, indicating stock is undervalued. Though both EBIT and EBITDA are neutral to capital structure (making them good to use when comparing similar firms in an industry), EBIT is more useful when fixed assets are less of a concern. EBITDA may make high asset companies seem healthier than they really are (Gavin, T). Price / Book Ratio: calculated as Share price / Book value per share When a firm’s value is unknown, this ratio helps valuate it in comparison to similar firms in the industry (Cheng & McNamara, 2002). A low P/B ratio could indicate that the stock is undervalued. It helps investors understand the value of their invested money and to see if their investment is costing more than it should. By examining this ratio, investors also have an idea of

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how their stock compares to the market price. With a P/B ratio of 1.09, STI investors should not expect large gains, as the ratio makes the representation that the stock may be slightly overvalued. A ratio below 1 indicates a potentially undervalued stock, thus increasing the chances of a larger return on investment. P/E Ratio: calculated as Share price / Earnings per share (EPS) The rounded P/E ratio of 8.97 suggests that STI is behind the national average. According to Damodaran’s resource website, the Trailing P/E ratio is 15.76 (Damodoran, 2018). In fact, based on the chart, all firms used are below average. This ratio is useful in determining if investors are overpaying for a company’s assets. In the case of STI, investors are paying $8.97 per $1 of STI’s earnings. Unique aspect of the ratio is that one cannot simply look at it to determine a company’s stock value, in terms of how it is performing in the market. It must be used in conjunction with other ratios or, as in this case, as a comparison tool between a company and its competitors. Only then can an investor conclude how the P/E ratio explains the financial state of a company’s stock.

Excess Returns Model In the attached Figure E.1, the Excess Returns Model calculations can be seen. According to Damodoran (2012) the excess returns model is used to calculate the intrinsic value of a stock, thus determining if it is valued correctly. The result of the valuation places a value of $41.89/share for STI. Recall that the current trading price is $52.18/share. This method is unique in that it focuses on excess returns, exclusively, while the previously discussed methods relied on returns and dividends as well as financial ratios.

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Note: This does not mean that investors should completely shy away from STI. Overvalued stock allows for the opportunity to sell stock, now, and buy later when the stock right sizes itself, within the market. Though this practice is a subject of debate, even prompting short-term bans in the financial sector (Tian, 2012). Conclusion In examining the valuation methods, the results are consistent in determining that STI’s stocks are currently overvalued, with the company having comparable ratios within what seems normal in its industry. It is noted that, even when completing the valuation by comparables, STI’s results were unremarkable, in terms of an unusually large variation in figures between STI and its competitors. The DDM and comparables analysis were useful in gauging how well STI performs, even though they have the smallest income in the group. A notable special challenge was locating the documents necessary to perform the analysis and choosing which values to use for analysis. Unfortunately, hours of research return just a small amount of data, compared to the quantity of resources available. Looking for reputable resources, and cross-checking them against one another, is a good practice to ensure that the data presented is as complete as possible. Overall, STI is a slightly overvalued company with the potential to realize small gains, over time. Considering that valuation requires many assumptions, this determination is not concrete and is subject to change with the market. A thorough valuation, however, should be accurate enough that sudden market changes are unsurprising and do not result in a grossly unexpected change in investor equity.

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WORKS CITED Cheng, A., & McNamara, R. (2002). The Valuation Accuracy of the Price-Earnings and PriceBook Benchmark Valuation Methods [Abstract]. Review of Quantitative Finance and Accounting,15(4), 349-370. Retrieved December 1, 2018, from https://link.springer.com/article/10.1023/A:1012050524545#citeas. Cochrane, J. H. (2017). Return forecasts and time-varying risk premiums. The Fama Portfolio: Selected Papers of Eugene F. Fama, 487-501. Damodaran, A. (2012). Investment valuation: Tools and techniques for determining the value of any asset (3rd ed.). New York: Wiley. Damodoran, A. (2018, January). PE Ratio by Sector (US). Retrieved November, 2018, from http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/pedata.html Gavin, T. (2012). The Great EBITDA Myth. AbfJournal. Retrieved December 5, 2018, from http://www.abfjournal.com/articles/the-great-ebitda-myth/ Tian, Haoshu. 2012. The Effects of a Temporary Short-selling Ban. Retrieved from https://scholar.princeton.edu/sites/default/files/htian/files/ssban.pdf, December 1, 2018.

WORKS REFERENCED Finviz (November-December, 2018) SunTrust Banks, Incorporated (STI). Retrieved from https://finviz.com/quote.ashx?t=sti&ty=c&ta=1&p=d

Yahoo!Finance (November-December, 2018) SunTrust Banks, Incorporated (STI). Retrieved from https://finance.yahoo.com/quote/STI SEC 10-K. (2017). SunTrust Banks, Inc. Retrieved from https://www.sec.gov/Archives/edgar/data/750556/000075055618000079/a123117stiform10kxreport.htm#sC75A201ADCD15C2D9C22DDC5F0955CE0 Finviz and Yahoo!Finance were also used to retrieve data used in valuation by comparables. Companies were accessed by entering stock symbol into the main page’s search bar....