DDM and Residual Income Model vs. DCF

Thank you so much!

Can you go over why you would use P/E, P/B, and P/TBV please?

P/E is standard. P/B and P/TBV show what the bank is trading at (stock price) relative to its ability to lend money and take on risk (BV), so it's a good industry multiple for financials. You wouldn't use EBITDA multiples for all the reasons listed above: interest expense is really a COG for banks, depreciation and amortization are tough because banks don't really have capex.

I think about P/B a little bit differently. P/B is the price you are paying for the net value of the assets (accounting value). Since measuring firm value is difficult as discussed above, we are really interested in measuring equity value. P/B gives us a sense for what the market thinks about the earning power of the bank's net assets (as BV is just total assets - total liabilities i.e., book value of equity). A high P/B means that the market values the assets at a significant premium relative to their book value. A low P/B implies the opposite, and a P/B 1 means a firm is not earning it's cost of equity capital. We use P/TBV just because tangible book value is less distorted by accounting choices over intangible assets, especially goodwill. TBV will not be materially different for two firms, one which grew organically and the other which grew through acquisitions, whereas P/BV could be very different for those two firms, even if all else was equal.

Are you planning to do FIG banking?

Yes, have any advice? My interview is tomorrow for an IB FIG Analyst role. It's at a top MM.

Good luck. No additional advice, you seem to be asking the right questions. Be prepared for why FIG, what trends there are in the FIG space, why MM vs. BB. Also FIG bankers will occasionally ask regular valuation questions, so don't forget those.

Hopefully be prepared to talk about a deal. There haven't been a ton recently in the banks space, but there are other things going on (Ally Financial selling international operations, Barclays buying ING deposits, Capital One acquired some ING business awhile back).

Which regular valuation do you think they will ask, wouldnt they just ask FIG specific ones, like walk more through a ddm model and residual model? Also, where would I find "what trends there are in the FIG space"? Thanks!

You could definitely still get asked things like "Walk me through a DCF?", "What are three ways to value a company?" etc etc. There are a couple of reasons for this: 1) Not all FIG is banks. There are lots of EBITDA based businesses in the FIG practice (maybe less so at your MM, but who knows). Asset managers and fintech are more traditional businesses 2) They don't always expect you to know everything about bank valuation. Sometimes they just want to see if you're smart and have done your homework, so they may ask standard questions

For trends, look at the FT financials section, look through old dealbook articles for financials deals. If you have access to CapIQ or another database use that. A primer on banks: 1) Low interest rates has led to NIM (net interest margin) compression, hurting profitability 2) Loan growth is slow. Banks are more conservative in new loans and there just aren't that many opportunities to make new good loans. This is tied in with the overall sluggish economy 3) These two things have put a lot of pressure on bank earnings. Consolidation is one way to address this (cost synergies, gaining market power, lower funding). We may be in store for a lot of upcoming consolidation in smaller regional banks 4) One bright spot is housing, which has been trending up. This is good for banks and their mortgage portfolios and origination. 5) Related to point 3), Dodd-Frank and Basel III compliance costs are going to hurt smaller banks. One way to mitigate this is consolidation. Compliance costs are fixed to a certain extent, so there can be large economies of scale when dealing with regulatory costs.