I don’t cover banks, but much of my investment portfolio is in bank preferred stocks. I love them. I have done my own valuations on them, but a very important part is estimating what the bank’s cost of preferred stock is to discount the preferred coupon stream.
I have my own way of estimating cost of preferred capital (which includes adjusting for different characteristics of preferred stock), but the hardest thing to pin down is determining the bank’s cost of equity. Using CAPM seems to be a common technique, but I feel like a sucker relying only on that. To supplement CAPM, I’ve estimated growth rates for banks and used them in FCFE and DDM models, along with current equity market valuations and solve for cost of equity to get a market-implied cost of equity. I come up with a blended estimated cost of equity using those different techniques.
Do any of you have any suggestions on better ways to determine a bank’s cost of equity? Is it as easy as just using CAPM? I was just curious given my lack of experience analyzing banks. Thanks.