The last article I published, we examined some of the fundamental factors that go into determining the intrinsic value of a company. We covered revenue, profitability, quality of management, and solvency. In this article, we attempt to value Goldman Sachs (GS), JPMorgan (JPM), Citigroup (C), and Bank of America (BAC): We'll use a present value discounted cash flow model and the price-sales multiplier model.
Discounted Cash Flow Model
For Bank of America 2010 and 2011 were tough years. The firm reported a net income loss in 2010 and profit of just under $1.5 billion in 2011. This year is shaping up to be a better year for the firm: Net income for the first six months of the year is just over $3 billion. That said, the price forecast for the next year should be representative of the improved earnings outlook. It is in that context that I estimate Bank of America's intrinsic value using a present value discounted cash flow model to be $10.29. The discounted cash flow model's estimated intrinsic value is in line with analysts at Barclays and Robert W. Baird. Further, given a current market price of $8, the estimated intrinsic value is roughly 29 percent above the market price. The model assumes that the dividend isn't increased in the next 12 months. The share price used to estimate the divergence from intrinsic value is $8.
Based on my estimates of intrinsic value using a discounted cash flow present value model, JPMorgan is fairly valued. The deviation from the estimated intrinsic value is not large enough for me to have the confidence needed to say that JPMorgan is undervalued. The intrinsic value estimate assumed the dividend remained constant over the next 12 months. Further, the share price used to estimate intrinsic value is $29.71.
Citi is fairly valued based on my estimate of intrinsic value using a discounted cash flow present value model. The problem with the model is estimating a future share price for Citi. Based on mathematically calculated share price forecasts the current share price doesn't diverge enough from the estimated intrinsic value to be considered under or overvalued. Further, based on the value-relevant fundamentals we previously examined, it seems as though the share price and the fundamentals are diverging: The value-relevant fundamentals of the firm are improving while the share price has pretty much been flat.
Goldman Sachs is slightly overvalued. Intrinsic value is estimated using a discounted cash flow present value model. The main assumption of the model is that the share price declines over the next 12 months. In the most optimistic forecast for the share price Goldman Sachs is fairly valued. In order to assign a 12-month target price that is above the current share price the trend would have to change from down to up. That said, my rough forecast for the value-relevant fundamentals is for an improvement compared to the year-ago period. The improvement would break the streak of worsening value-relevant fundamental factors.
Models are simplifications of reality and are subject to forecasting errors. That said, based on the results, Bank of America appears undervalued using this valuation model. Results from Citi and Goldman Sachs are inconclusive: I don't have enough confidence in the price forecasts. However, the fundamentals of Citi are improving, but the share price is underperforming, and Goldman's fundamentals may also be improving.
Bank of America
(click to enlarge)The price-sales valuation metric is approaching the high of the year: The valuation metric is suggesting Bank of America could be short-term overvalued. Sales over the past five years declined at an annual rate of 8.22 percent. Sales in the most recent quarter versus the year-ago quarter declined 18.3 percent. The current price-sales value for the twelve trailing months is 1.44.
(click to enlarge)The price-sales valuation metric is approaching the high of the year: The valuation metric is suggesting Goldman Sachs is fairly valued on a short-term basis. Sales over the past three years declined at an annual rate of 11.78 percent. Sales in the most recent quarter declined 10 percent compared to the year-ago quarter. The current price-sales value is 1.56.
The price-sales valuation metric is approaching the middle of the range: The valuation metric is suggesting Citigroup is fairly valued on a short-term basis. Sales over the past three years declined at an annual rate of 11.96 percent. Sales in the most recent quarter declined 8.4 percent compared to the year-ago quarter. The current price-sales value is 1.23.
(click to enlarge)JPMorgan is currently short-term fairly valued based on the price-sales valuation metric. Sales over the past three years declined at an annual rate of 5.67 percent. Sales in the most recent quarter declined 9.8 percent compared to the year-ago quarter. The current price-sales value is 2.40.
JPMorgan's price-sales ratio is much higher than the other firms: Part of that can be attributed to a slower decline in sales over the past three years. However, JPMorgan's sales decline in the second quarter was larger than Bank of America's and Citigroup's: Should that trend continue or should evidence suggest that trend will continue JPMorgan probably wouldn't deserve the premium sales valuation. Further, Goldman Sachs has a much higher sales valuation than Citigroup: Goldman's sales performance wasn't better than Citi's. That said, Citigroup appears to be undervalued on a price-sales basis: The firm's sales performance was relatively good and it is trading at a much lower multiple.
To be continued...
Disclaimer: This article is not meant to establish or continue an investment advisory relationship. Before investing, readers should consult their financial advisor. Christopher Grosvenor does not know your financial situation and ability to bear risk and thus his opinions may not be suitable for all investors.