Banks are among the most complex businesses to value, especially from the outside in. Published accounts give an overview of a bank’s performance, but the clarity of the picture they present depends largely on accounting decisions made by management. External analysts must therefore make a judgment about the appropriateness of those decisions. Even if that judgment is favorable, analysts are still bound to lack vital information about the bank’s economics, such as the extent of its credit losses or any mismatch between its assets and liabilities, forcing them to fall back on rough estimates for their valuation. Moreover, banks are highly levered, making bank valuations even more contingent on changing economic circumstances than valuations in other sectors. Finally, most banks are in fact multibusiness companies, requiring separate analysis and valuation of their key business segments. So-called universal banks today engage in a wide range of businesses, including retail and wholesale banking, investment banking, and asset management. Yet separate accounts for the different businesses are rarely available.
When you are valuing banks, the basic approach to valuing industrial companies, set out in Part Two, is the right way to start. However, if you want your valuation to reflect the complexities of today’s banking businesses and to yield insights into where and how a bank is creating value, then the process of valuation becomes more complicated, as there are significant ...