Valuing Financial Institutions
With the turmoil in the world’s financial markets over the last few weeks we have been asked why we don’t have valuations of financial institutions here at Valuecruncher. The last few weeks have actually shown exactly the reason why we don’t.
When we launched Valuecruncher our objective was: “making the valuation methodologies used by corporate finance professionals more accessible to a wider audience”. To achieve this we provide a three-year discounted cash flow (DCF) calculator. This approach works well for most companies. However there are several instances where it does not. One of these is financial institutions.
For financial institutions (such as Goldman Sachs) a key to understanding their intrinsic value is the value of assets and liabilities held on their balance sheet – in the form of different financial securities. These assets and liabilities are difficult to value (as an outsider) in normal times – and almost impossible at the moment. This isn’t the case for a company like Microsoft – where balance sheet items (such as cash) are important but easy to measure. Microsoft’s value is driven by the cash it generates from selling software – and adjusting for cash and any debt on the balance sheet. Goldman Sach’s earnings are important – but not as important as changes (both positive and negative) to the securities they hold on their balance sheet. As the current financial conditions illustrate – the value of these assets can move quickly and dramatically.
Some quick numbers:
Microsoft: 2008 revenues US$60.4bn, operating income US$22.2bn, total assets US$72.8bn, total liabilities US$36.5bn, total equity US$36.3bn. Market Capitalization US$250bn.
Goldman Sachs: 2007 revenues US$88.0bn, operating income US$17.6bn, total assets US$1,119bn (US$1.1 trillion), total liabilities US$1,077bn (1.1 trillion), total equity US$42.8bn. Market Capitalization US$54bn (Note: this market capitalisation is approximately 55% of the 52 week high).
Two companies with comparable revenues and operating income (and total equity) – but very different balance sheets.
Valuecruncher will help you to value Microsoft – but not Goldman Sachs. Here at Valuecruncher we are focused on providing tools for valuing listed companies. If the tools we provide are not appropriate for a particular company or industry (i.e. financial institutions) then we will exclude those companies.
Note: the other significant industry that we don’t cover at Valuecruncher is natural resources companies. This is for a similar reason. The value of natural resources companies is driven by the assets they hold (i.e. oil and gas deposits) not near-term cash flows. Hence we don’t cover natural resources companies either.