Abstract
This report analyzes a mid-west regional bank in the U.S. that provides various banking and financial services to individuals and businesses. We call the bank ABC Bank for the purposes of confidentiality. To determine the appropriate investment recommendation for this company, I have applied discounted cash flow valuation and relative valuation approaches to determine whether its stock is undervalued, overvalued, or fair valued. In addition, in order to evaluate ABC Bank’s financial strength against unexpected losses, I have utilized its tier 1 capital and tangible common equity (TCE) ratios to judge its future viability. Source of Data I have analyzed the five-year historical data of ABC Bank’s 10Ks to determine the range and performance of the major items, such as loan balance, deposit balance, net interest margin, and efficiency ratios. Then, based on different assumptions of the economy, we have developed four scenarios to forecast financial performance over six years to determine the company’s earning capability and financial position. In addition, from ABC Bank’s proxy statements, we select other five mid-west regional banks to estimate ABC Bank stock’s fair value by the price-earnings and the price-to-book values ratios. The companies’ current stock prices, past year earnings, forecasted earnings, and book values of their common equities were required for the relative valuation approach. Conclusions Based on the residual income valuation for different scenarios, I estimate ABC Bank’s weighted average intrinsic value to be $15.87 per share and its target stock price to be $14.77 per share based on the review of PE multiples. As the economy showed signs of stabilization as of August 2009, ABC Bank is expected to improve its profitability in 2010. Accordingly, I would suggest that investors buy and hold at the current price of $10.29 per share and sell when it reaches the target price of $14.77 to $15.87 per share. Moreover, by forecasting ABC Bank’s tangible common equity ratio under different scenarios, I determine that the bank has enough financial strength to confront the unexpected loan losses.