National Bank: Analysts, Investors are Undervaluing the Stock

National Bank of Canada (TSE: NA) provides commercial banking and financial services. It operates through the following segments: Personal and Commercial, Wealth Management, Financial Markets, US Specialty Finance, International, and Other. 

National Bank recently reported earnings, which beat expectations. Earnings per share came in at C$2.55, above analysts’ expectations of C$2.25. Revenue was C$2.44 billion, which also beat the consensus of C$2.38 billion.

NA’s share price is down roughly 1.3% year-to-date but up approximately 8.5% in the past year. Nevertheless, the stock may be attractively priced at the moment due to its recent pullback.

Is National Bank Stock Undervalued?

To value National Bank of Canada, we 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

We will use the following assumptions for our calculations:

Average ROE: 17.8% (five-year average)
Cost of Equity: 7.8% (value taken from Finbox)
Book Value: $55.72
Growth Rate: 2.88% (used 30-year Government of Canada bond yield as a proxy for long-term growth expectations)

Now that we have our assumptions, let’s plug them into the formulas:

$5.57 = (0.178 – 0.078) x $55.72
$113.21 = $5.57 / (0.078 – 0.0288)
$168.93 = $55.72 + $113.21

As a result, National Bank of Canada is currently worth C$168.93 per share under current market conditions. However, it would likely take a few years for the stock to realize its intrinsic value, especially since markets are worried about inflation and a potential recession.

National Bank’s Dividends

For income-oriented investors, NA pays a 3.79% dividend yield on an annualized basis. When taking a look at National Bank’s historical dividend yield, you can see that it has trended downwards:

At 3.71%, 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.

Analyst Recommendations

National Bank of Canada has a Moderate Buy consensus rating based on five Buys, four Holds, and one Sell assigned in the past three months. The average National Bank of Canada price target of C$105 implies 7.9% upside potential.

Final Thoughts

National Bank had a solid quarter, as it beat analysts’ expectations. Although analysts see minimal upside potential, the excess returns model suggests that the market may actually be mispricing the stock by a larger amount.

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