Most important non-financial factor in company valuation is IR, shows research

Is your company fairly valued? What factors drive that valuation? And what steps could you take to achieve a fairer valuation? These are just some of the questions being answered by Iridium Advisors’ artificial intelligence (AI) algorithms.

The Dubai-based IR firm last year published the first report on its research, with the finding that professional IR was adding up to a quarter of the value at banks in the Gulf Cooperation Council (GCC) region. Now Iridium has published a new paper on its findings, again highlighting the real value of IR.

Its latest paper, How machine learning can unlock shareholder value, which again focuses on banks, assesses 10 mn data points and more than 30 explanatory variables for 750 banks from 96 countries. The results point to high-quality investor relations as the most important non-financial metric impacting company valuation.

‘We found the most important individual factor in the prediction of the price-to-tangible-book-value (P/TBV) was the non-performing loans ratio, which explains 7.2 percent of valuations in aggregate,’ write the report authors. They add that this is perhaps not surprising given the fact that non-performing loans ‘are a key risk metric for banks that investors typically scrutinize in depth, especially in the current market environment. In relation to non-financial factors, investor relations quality is most important, explaining 5 percent of P/TBV variability.’

Other non-financial factors of notable importance include strong credit ratings, ‘which are typically viewed more as drivers of debt pricing’ but which are ‘surprisingly’ also ‘important determinants of equity valuations’. Finally, MSCI country classifications are the third-most important non-financial factor, says Iridium.

‘This kind of insight can be [used] by company management and the investor relations team to focus their investor communications on the most important performance indicators to ensure the market fully understands them, thereby promoting fair valuation of their stock,’ write the report authors.

Bank for bank

The paper offers a real-world example, looking at two banks in the GCC region, examining whether each bank is fairly valued and digging into the factors affecting valuation. First up, Iridium offers National Bank of Kuwait (NBK), looking at the stock in Q2 2021. The firm’s AI models accurately predicted NBK’s valuation – or, as it points out, the bank is fairly valued.

It also notes that most of NBK’s value drivers are positive. These include:

Company-specific effect – A persistent company-specific premium, which Iridium says ‘is reflective of a strong management track record and bank franchise’

Country effect – The country in which the bank operates, which currently attracts a valuation premium

Long-term credit rating – The company’s valuation benefits from a strong, long-term credit rating

Size effect – At this point in time, investors are paying a premium for larger banks.

For Bank Dhofar, based in Oman, Iridium says the bank appeared undervalued at the time of the research, ‘with a 15 percent delta between actual and predicted P/TBV’. It highlights a number of factors bringing down the valuation, including:

Company-specific effect – A persistent company-specific discount is reflective of perceptions of a weaker management track record and bank franchise

Country effect – The country in which the bank operates currently attracts a valuation discount

Long-term credit rating – The company’s valuation is negatively impacted by its slightly below ‘average’ credit rating

Size effect – At this point in time, investors are paying a discount for smaller banks.

So what should these banks – neither of which is a client of Iridium’s – do with this information? ‘For NBK, the focus should be on defending its premium valuation and continuing its efforts to maintain its strong credit rating and improve its IR quality in an ever-changing capital markets landscape,’ writes the firm.

‘For Bank Dhofar, several opportunities exist to improve the valuation, including upgrading its IR capability, improving its communication efforts to build credibility in its track record, and optimizing its financial strategy.’