Valuation of a private financial services company
Hi there,
This is my first topic in this forum and I would like to ask a question regarding the theory of the valuation of a private financial services company. Sorry if this topic has came up before, but I was just not able to find.
Generally speaking, the valuation of a private company is usually done by DCF or multiples (or even NAV) methods, however we know that using DCF by taking EBIT/ EBITDA would not be appropriate for the valuation of a financial services company (say, a bank). Moreover, we know that banks have different capital structure, therefore traditional FCF methods are generally not used, and DDM is advised for this kind of valuation.
I will not try to discuss which model to use with regards to valuation of a financial services company and im assuming the DDM model is being used here.
My question here is; With this type of model, after properly calculating the RWA and required Tier 1 and Tier 2 capitals, usually a hypothetical dividend is calculated by taking the difference between the minimum required capital (remember the company is private thus does not pay any dividends) and the common equity.
However when we have set the minimum level of required capital and take the rest as dividends for valuation purposes (which we will discount later), does not that imply that we are overestimating the amount of dividends (hypothetical) the company can pay, thus the whole valuation?
In other words, usually companies, even banks do not pay everything as dividends (dunno the average but say 50-60% or even less) however, are not we assuming here, in this type of model, that after the minimum capital is set, everything else is distributable dividend?
And following that, with the terminal value calculation (assuming, growth(g) is retention ratio*RoE), isn't it going to be really low as nearly 90% of net income is distributed as dividends every year, hence making the growth really small?
Sorry if this has been too long and confusing, hope I was clear enough.
Thanks all.
Value on earnings, (tangible) book value, and dividends.
Over the long-term you should assume there will be more clarity around regulatory capital constraints -- the more difficult question is the appropriate capital requirements to apply to a given firm -- there isn't a ton of clarity at this point and it is rapidly developing.
I'd probably just value off of earnings instead of dividends, especially if you're talking about a controlling interest in a private company.
OP, not directly related to the topic, but i'm curious, what drivers did you use for interest income and balance sheet?
the sustainable growth formula is tricky to implement with a lot of implied assumptions. theoretically, it sounds like a very good and intuitive way to determine growth. however, it sometimes leads to non-sensical results especially if you try to back into the components at the current 4-5% long-term nominal GDP growth outlook as a benchmark PGR. For example, assume 5% PGR and you have a 10% plowback ratio, the sustainable growth formula implies an ROE of 50%.
Thanks for the replies guys. @BDN, sorry i did not understand clearly what you meant. Interest income is not very hard to get, I would just take average NIM of big banks as a starting point. For balance sheet, if I understood correctly, I am projecting a growth of risk weighted assets in line with loan growth which I think should be ok. But even if not, assume the numbers are given. My main concern here was the perpetuity growth rate which is critical for the valuation purpose, assuming around 90% of net income will be paid as dividends.
But def. agreed with fin_greek, as the sustainable growth formula does not really work very good in this way, either stating a huge RoE or a very small growth. I guess the solution here is that, we must be assuming a growth rate (it must be given like 6%), and calculate the retention ratio accordingly, given the sustainable RoE (making Retention Ratio around 50-60%), which makes a more robust valuation in my opinion. Thus we will be giving away lots of dividends during the projection period, and then sustainable ratios are lower.
Other than that, no solution to this type of model comes into my mind..
Hello, Valuation of a company or firm is depends on many factors. One should keep in mine all these factors while valuation of a company.
Thnks......
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