Why You Can't Value Banks Like You Do Other Companies

As Managing Director and Head of Global Financial Strategies at Credit Suisse, Michael Mauboussin advises clients on valuation and portfolio positioning, capital markets theory, and competitive strategy analysis. He has also authored three books -- Think Twice, The Success Equation, and More Than You Know -- and is an adjunct professor of finance at the Columbia Business School, and chairman of the Board of Trustees at the Santa Fe Institute.

Banks and financial companies differ from other businesses in their accounting methods and the role of debt -- hence the disclaimer -- but they can still be analyzed in terms of the fundamentals: present value and future cash flows.

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A transcript follows the video.

Koppenheffer: I focus a lot on financial companies and banks, and usually in that sort of thing there is a disclaimer of, "For non-financial companies." Would this same kind of analysis work for a bank or a financial company?

Mauboussin: It would, yes. I usually put those disclaimers in, myself!

I think, for banks, we tend to use less P/Es -- well, you're the expert, not me -- but less on multiples, and more on things like price to book. The reason is because book value for a bank is market-to-market, so you presume that that asset value is something that is current in terms of the values.

But the ideas are the same, no question. Same thing; banks have current activities. If they keep doing them, what are the things they can do in the future? That could be expanding, for example, your retail bank franchise, it could be expanding your loan book in some other part of the world, what have you.

Those concepts would still apply; maybe a little trickier, but I think they would apply.

Koppenheffer: Just while we're on the subject, that disclaimer in general ... in thinking about a bank or a financial company, is it that much different? Thinking about a guy like Buffett -- Berkshire (NYSE: BRK-B  ) (NYSE: BRK-A  ) owns Wells Fargo (NYSE: WFC  ) as its biggest holding -- and he's thinking about that in terms of its franchise value, so there is an overlap with something like a McDonald's (NYSE: MCD  ) .

Mauboussin: No question Matt, and I would just say, going back to first principles, present value, future cash flows -- that, we can say, is fairly universal; any asset class, any sector of the economy, what have you, so you're right.

I think that the reason we often say the disclaimer is because the nature of the accounting is slightly different, and the role of debt, for example, is quite different. Debt is often considered to be almost like a raw material for a bank.

Typically our cash flow model is, instead of a free cash flow discounted back to the firm value, for banks or insurance companies it's usually equity cash flow that's discounted back to an equity value. So, there are some differences in the details, but the basic concept, the big picture concept, absolutely is the same thing.


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