FINANCE

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 byDCFor multiples (or even NAV) methods, however we know that using DCF by taking EBIT/EBITDAwould not be appropriate for the valuation of a financial services company (say, a bank). Moreover, we know that banks have different capital structure, therefore traditionalFCFmethods 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.


Category: Financial services

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