Markets

Can Sun Life Financial Stock (TSE:SLF) Continue to Outperform the Market?

Sun Life Financial (TSE: SLF) (NOT: 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 can outperform the market in the future. SLF outperformed the US market in multiple timeframes when it included dividends. Below is a chart of year-to-date performance, with its performance relative to the S&P 500 (SPKS) measured in US dollars. It even outperformed the TSX index when measured in Canadian dollars. Despite a perfect smart score and solid results, the stock’s valuation doesn’t leave much upside potential. Therefore, we are neutral on the stock for now.

Year-to-date performance of SLF stocks (blue) vs. S&P 500 (orange) (Source: TradingView)

Is SLF a high-quality stock?

Sun Life is a high quality stock. About three months ago, we wrote a stock analysis article on SLF that talked about its upsides, which include steady growth in earnings per share (EPS) and book value per share. Also, its dividend, which yields 4.57%, has grown consistently (at a 10-year CAGR of 6.7%), and its five-year average return on equity of 12.1% is considered good.

Although its long-term growth in terms of book value, earnings and dividends can provide solid returns for investors, these returns may not be anything too significant. When we wrote our last SLF article, the stock was trading near C$57. It is now trading above C$63, giving it less upside potential. Let’s discuss his assessment below.

Sun Life shares may be slightly overvalued

To value Sun Life stock, we’ll 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 does not work well. The excess returns model allows us to use historical numbers instead, which are tangible. There are several steps to follow for this assessment method.

First, you calculate the company’s excess return, which means the difference between its return on equity (ROE) and its cost of capital; a higher ROE than cost of capital is a good thing. Then you calculate its terminal value. Add them up and you get your estimate. Here is the formula:

  • Excess return = (average ROE – cost of equity) x book value per share
  • Terminal value = excess return / (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 capital: 9.8%

Book value per share: C$45.18

Growth rate: 3.17% (uses the 30-year Canadian government bond yield as a proxy for long-term growth expectations)

Now that we have our assumptions, we will 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 C$60.85 under this valuation method. Its current share price is close to C$63, making it slightly overvalued.

Is SLF stock a buy, according to analysts?

SLF stock receives a consensus rating of moderate buy based on five buy ratings and three hold ratings assigned in the last three months. SLF stock’s average forecast of C$66.84 implies a potential upside of 5.9%.

Takeaway: SLF Stock is sending mixed signals

To summarize, 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’s probably a better idea to wait for a pullback, as his valuation has room to drop. Also, analysts predict only 5.9% growth potential for the coming year, which is not a reason to get excited. So we are neutral.

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