Introduction
Sun Trust Banks, Inc. is an American bank holding company which was established in 1891. As of March 31 st , 2018, SunTrust band, the Company largest subsidiary, had 199 billion US dollars in assets ( Bank, 2018 ). As of September 2016, the company had 1,400 bank branches and 2160. SunTrust banks offer a wide range of financial services including lending, deposits, credit cards, investment services, and trust. It offers services in mortgage banking, corporate and investment banking, wealth management, and capital market services through its various subsidiaries ( Bank, 2018 ). The estimated number of the Company’s employees is approximately 24,000. As of June 30, 2016, revenues from consumer banking was the highest at 32%, followed by corporate and investment banking at 20%, commercial and business banking at 14%, private wealth management -12%, mortgage-11%, consumer lending-8%, and commercial real estate-3% ( Bank, 2018 ). The purpose of this paper is to conduct a security analysis and valuation of Sun Trust Banks, Inc. The valuation models used in this study include Comparable Company Analysis Model, Dividend Discount Model (DDM), and Damodaran Excess Return model.
Valuation using the three valuation model will ensure a better presentation of the financial institution’s fair value. The estimated fair value is important in the analysis of the institution’s security performances. The calculated values provide a clear overview of the company’s stock performance, and how it compares with peer institutions. Company valuation and security analysis are important for investors in determining if it is viable to invest in a given security. Therefore, this paper also provides information on whether the company’s stock is currently undervalued or overvalued as well as the right model for financial institution valuation.
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Sun Trust Banks, Inc. financial information used in this study is retrieved from Yahoo! Finance, the institution’s 10-K annual report, and Morningstar Financials.
Analysis
Comparable Company Analysis
Comparable Company Analysis (CCA) is a corporate valuation method whereby a given company’s value is determined using the metrics of peer companies or valuation multiples ( Young & Zeng, 2015 ). This method of valuation assumes that institutions of the same size in the same industry have similar valuation multiples. Common valuation multiples include enterprise value (EV) multiples such as EV/EBITDA, EV/EBIT, EV/Sales, as well as equity value multiples such as price/EPS (P/E), PEG ratio, and equity value/book value ( Young & Zeng, 2015 ). The multiple used to analyze Sun Trust Banks, Inc. is the price-earnings ratio. The average industry multiples are compared to the Sun Trust’s average multiples over the last five years ( Young & Zeng, 2015 ).
The table below shows the average PE for Sun Trust and its peers.
| Industry Price Earnings (PE) Ratio | ||
| Peer | Ticker | PE Ratio |
| JP Morgan Chase & Co | JPM | 12.43 |
| Bank of American Corporation | BAC | 11.16 |
| Wells Fargo & Company | WFC | 10.6 |
| BB & T Corporation | BBT | 12.31 |
| Industry Average | 11.625 | |
| Standard Deviation | 0.891459477 | |
| Sun Trust Banks, Inc. (STI) PE Ratio | |
| Year | PE Ratio |
| 2014 | 12.77 |
| 2015 | 12.64 |
| 2016 | 15.19 |
| 2017 | 16.56 |
| 2018 | 8.98 |
| Average | 13.228 |
| Standard Dev | 2.896233761 |
Sun Trust’s value using comparable company analysis is 13.228× its earnings per share.
Sun Trust’s earnings per share is currently at 5.82.
Therefore, the value of its stock is 13.228 × 5.82 =$ 76.98. The institution is currently undervalued at a stock market price of $52.18.
Dividend Discount Model
Dividend discount model is a company’s stock valuation method whereby all future dividend payments are discounted back to their present value ( Young & Zeng, 2015 ). The dividend discount model (DDM) assumes that the value of a company’s stock equals the sum of its future dividend payments ( Young & Zeng, 2015 ). The formula for the stock price in dividend discount model is given by:
P =
where P is the value of the stock, g is the constant dividend growth rate, r is the cost of equity capital, and D1= next year’s expected dividend. This model’s main assumption is that an investor purchases stock with sole purpose of receiving dividends in perpetuity. The model entails approximating future dividend payments and determining a discount for future payments. The expected sustainable growth rate g is found in excel using the formula:
Expected growth rate = Return on Equity (ROE) × (1 –Dividend Payout Ratio)
The growth rate = 8.33%
Additionally, r is determined using the CAPM model.
= R f + β (R m –R f ) where R f is the 10-year US Treasury bond rate, R m is S &P annual rate of return, and β is the Beta of Sun Trust
= 9.73%
The value of the stock estimated using the discounted dividends model calculated in excel is $ 143.47. This means that Sun Trust’s bond is undervalued at a market price of $52.18.
Damodaran Excess Returns Model
The third model for the institution’s valuation is the Damodaran Excess Returns Model. According to Damodaran model, the value of a firm is the sum of the currently invested capital in the institution and the intrinsic value of excess returns the institution expects to make in the future ( Damodaran, 2016 ).
Value of a firm =
This model is applicable when valuing equity in a financial institution.
When using an excess return model, it is sensible to focus on just equity because of the difficulties in determining the total capital of the financial institution ( Damodaran, 2016 ) . The value of a company’s equity is the equity invested in the company’s current investments added to the expected excess returns to equity earned from current and future investments ( Damodaran, 2016 ) .
This model requires equity capital currently invested and expected excess returns to equity. The equity capital currently invested is the book value of equity in the firm. The value is then divided by the number of shares outstanding to find the fair value of the stock.
| Net Operating Profit After Tax | $2,282,000,000 |
| Invested Capital | $22,576,000,000 |
| WACC (Cost of Equity) | 9.73% |
| Excess Equity Return | $85,355,200 |
| Present Value of Excess Equity | $877,237,410.07 |
| Beginning book value of equity | 22,290,000,000 |
| Value of Equity | $23,167,237,410.07 |
| Shares Outstanding | 469,010,000 |
| Stock Value | $49.40 |
The fair value of the Sun Trust stock is $49.40 which is almost equal to the current price of $52.18. It is slightly overvalued at $52.18.
The consistency of the Valuations
| Valuation Model | Stock Value |
| DDM –Constant Growth | $143.47 |
| Valuation by Comparable | $76.18 |
| Damodaran Excess Returns | $49.40 |
| Current Market Price | $52.18 |
There is a difference in the stock value obtained from different methods of company valuation. The Damodaran Excess Returns model indicates that the institution is slightly overvalued while its book value is close to the market value of the stock. The other methods, comparable analysis, and dividend discount model indicate that the institution’s stock is undervalued at the market price of $ 52.18. The difference between the values of the stock is attributed to the different assumptions under each model. For instance, the dividend discount model assumes that the sole goal of investment is to earn dividends to perpetuity while in the real sense there is no business which lasts forever. Damodaran excess returns model seem to be the most accurate model due to its proximity to the market value of the stock.
Challenges Encountered in the Valuation of Financial Institution
It is difficult to determine the real value of a financial institution because the valuation of the firms is based on equity as the only source of capital; financial institutions don’t regard debt as a source of capital. Also, it is difficult to determine the appropriate method of valuation; each valuation method gives different results. Hence, it is always confusing when determining the accurate value of financial institutions. Additionally, some assumptions under each model are no true in real practice. For instance, DDM assumes a constant dividend growth rate. However, there are market forces which can make dividend growth rates vary in the future. Thus, the calculated stock values can only be regarded as estimates and not accurate values.
Conclusion
The valuation of Sun Trust Banks, Inc. using three different methods produced different results. Comparative company analysis model and the DDM model showed that the company is undervalued at the current market price. The Damodaran excess returns model showed that the company is slightly overvalued. The stock valued obtained from the Damodaran excess returns model was very close to the market value of the stock. This closure indicates that the Damodaran excess returns model is the most accurate financial institution valuation model among the three.
References
Bank, S. (2018). Elaine Lo.
Damodaran, A. (2016). Damodaran on valuation: security analysis for investment and corporate finance (Vol. 324). John Wiley & Sons.
Sun Trust Banks, Inc. (STI) (2018). Profile, business summary. Morningstar. Retrieved from https://www.morningstar.com/stocks/xnys/sti/quote.html
Sun Trust Banks, Inc. (STI) (2018). Profile, business summary. Yahoo! Finance . Retrieved from https://finance.yahoo.com/quote/STI?p=STI
Young, S., & Zeng, Y. (2015). Accounting comparability and the accuracy of peer-based valuation models. The Accounting Review , 90 (6), 2571-2601.
