Can Sun Life (TSE:SLF) Financial Stocks Continue to Outperform the Market?
Sol financial life (TSE: SLF) (New York Stock Exchange: SLF) is a Canadian financial services company and one of the world’s largest insurers. It also has a ‘Perfect 10’ smart score, which implies that it may outperform the market in the future. SLF has outperformed the US market on multiple time periods when including dividends. Below is a year-to-date performance chart, with its performance against the S&P 500 (SPX) measured in US dollars. It has even outperformed the TSX index when measured in Canadian dollars. Despite its perfect smart score and strong track record, the stock’s valuation doesn’t leave a lot of upside potential. Therefore, we are neutral on the action for now.
Is SLF a high quality stock?
Sun Life is a high quality stock. About three months ago we wrote an SLF stock analysis article who discussed its positive aspects, which include steadily growing earnings per share (EPS) figures and book value per share. In addition, its dividend, which yields 4.57%it has grown steadily (at a 10-year CAGR of 6.7%) and its five-year average return of 12.1% is considered good.
While its long-term growth with respect to book value, earnings, and dividends can provide strong returns for investors, these returns may not be very substantial. When we wrote our last SLF article, the shares were trading around C$57. It is now trading above C$63, giving it less upside potential. We will discuss his valuation below.
Sun Life shares may be slightly overvalued
To value Sun Life shares, we will use the excess return model, which is more appropriate for financial companies because they tend to have volatile free cash flows.
As a result, trying to create forecasts for them doesn’t work well. The excess return model allows us to use historical numbers instead, which are tangible. There are a few steps to follow for this valuation method.
First, it calculates a company’s excess return, that is, the margin between its return on equity (ROE) and its cost of capital; ROE higher than cost of capital is a good thing. Next, calculate its terminal value. Add them up and you will get your assessment. Here is the formula:
- Excess return = (average ROE – cost of capital) x book value per share
- Terminal Value = Excess Yield / (Cost of Capital – Growth Rate)
- Fair value = book value per share + terminal value
We will use the following assumptions for our calculations:
Average return on equity (ROE): 12.1% (five-year average)
Cost of own resources: 9.8%
Book value per share: C$45.18
Growth rate: 3.17% (Canadian 30-year government bond yield used as proxy for long-term growth expectations)
Now that we have our assumptions, we’ll plug them into the formula highlighted above. Figures are in Canadian dollars:
- $1.039 = (0.121 – 0.098) x $45.18
- $15.67 = $1.039 / (0.098 – 0.0317)
- $60.85 = $45.18 + $15.67
Therefore, SLF shares are currently worth Cdn$60.85 under this valuation method. Its current share price is close to C$63, making it slightly overvalued.
Are SLF shares a buy, according to analysts?
SLF shares earn a Moderate Buy consensus rating based on five Buy and three Hold ratings assigned in the last three months. The median forecast for SLF shares of C$66.84 implies upside potential of 5.9%.
Takeaway: SLF shares are sending mixed signals
In summary, Sun Life Financial is an excellent company that has the potential to generate solid returns from here, and its Smart Score suggests the same. However, it is probably a better idea to wait for a pullback, as its valuation has room to go down. Furthermore, analysts are only forecasting a 5.9% upside potential for the coming year, which is not a cause for enthusiasm. Therefore, we are neutral.
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