Federal Bank: Dividend Discount Valuation Model Case Study Analysis
Alternative Valuation methods
In order to reach a conclusion regarding the investment in federal bank’s shares and evaluating if the shares qualify for a purchase, P/E multiple of the industry has been used to estimate the value of the organization’s shares.
P/E multiple Valuation Approach
The P/E multiple approach is a valuation technique used to estimate the share price of an organization by benchmarking the organization’s financial performance with similar organizations in the industry. In order to estimate the bank’s P/E ratio, the P/E multiples of its competitors that includes ICICI bank, Axis Bank, HDFC Bank and Kotak Bank has been used. The average P/E ratio of private banks in India was estimated to be 20 times and the value of Bank’s share price amounted 197 Indian Rupee which is calculated adjusted EPS of 2014 i.e. 9.81 Indian Rupee.
The share price predicted is significantly higher as compared to the current share price of 48 Indian Rupee which suggests that the current share price is undervalued and the bank’s shares qualifies for a buy considering purchasing undervalued stock will befit the investor in terms of higher yield, higher total return and lower investment risk. (See Appendix 3)
Qualities of Organizations with Undervalued Stocks
The qualities or indicators of a company with undervalued stocks are mentioned as follows:
- The bank does not specialize in high technology which can become obsolete overnight.
- The organization earns stable profits
- Low P/E ratio does not indicate major decline in profitability
- Company’s profits are not reduced even in times of economic recession
- The organization’s P/E ratio is below the average P/E ratio of the industry in which it operates
The above traits of an organization with undervalues stock suggests that Federal Bank’s stocks are undervalued as even due to adverse macroeconomic factors, the organization maintained the same profit levels. The low P/E ratio of the bank is not attributed due to low or decline in profitability and the bank’s P/E ratio is below the Average industry P/E multiple of 20 times. (Berkshire Hathaway Inc, 2020)
Recommendation
Based on strategic assessment, estimation of intrinsic value using Dividend Discount model and P/E multiples valuation approach, it is concluded that the price of the Federal Bank’s shares is significantly undervalued and the business has significant potential for future growth. In addition, the bank enjoys strong financial performance and positions, therefore, it is concluded that the Federal Bank qualifies as a potential undervalued target and Malhotra should invest in the shares.
Conclusion
Federal Bank is the largest private bank located in the state of Kerala. India. Despitebeing the largest bank in India, federal bank P/E ratio was significantly lower as compared to P/E ratio of the private banks in the country. He bank’s stocks were concluded to be undervalued as the estimated intrinsic value of 178 Indian rupee calculated using Dividend Discount Model and estimated share price of 197 Indian Rupee was significantly lower as compared to the current share price of 48 Indian Rupee.
Furthermore, the bank had the traits of companies with undervalued stock which suggested the price of the bank’s stock was significantly undervalued. It was concluded that the bank had great potential for growth in the foreseeable future therefore, it was recommended to the investors to purchase the bank’s stock as purchasing undervalued stock enables the investor to enjoy benefits, which include: lower investment risk, capital appreciation, dividend growth and significant investment return...................................
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