Hacker News Reader

Comment by cm2187 | Hacker News Reader

I like to think that there are two extremes for valuations.

On one side of the range, the consulting firm, which has no assets, and which value is a pure function of future earnings.

On the other extreme you have an investment fund where the value is purely a function of the value of the assets which are all liquid financial assets. You don't buy the fund at a premium, otherwise you might as well buy the underlying assets yourself.

A bank is somewhere between the two. It has what should be a reasonably reliable accounting value since at the end of the day, all of its assets are financial assets that can be sold and aren't highly specialised like a factory or a hotel building is. But on the other side a large part of the value is not just the balance between assets and liabilities. It has additional earnings (fees, trading activities, etc).

View on HN

Consulting firms generate revenues. Their assets are mostly human capital, but their value is generally a multiple of current earnings, not "a pure function of future earnings".

Most banks hold a decent amount of highly specialized, illiquid debts that have no active market and could reasonably be compared in terms of liquidity to real estate or capital goods.

I am not sure I understand your point. How is that different from what I wrote.

And no, there are no line in an IFRS balance sheet for "human capital".

[edit] and on your second point, I don't think I agree. You will pretty much always find a buyer for financial assets. Unless they are so rotten that no one thinks they are worth what you have them in your books for (which may be the case for some Italian banks).

Where I think you are right to be careful with banks is with the size. If you need to wind down a massive international bank, you need to find buyers for a awfully large amounts of assets, and that will likely damage their value.

> I am not sure I understand your point. How is that different from what I wrote.

Yeah, we are on the same page, it was just a little nit as it seems weird to me to state that future revenues are the "pure" base for valuation when future is informed by current. Just semantics though.

> You will pretty much always find a buyer for financial assets. Unless they are so rotten that no one thinks they are worth what you have them in your books

At the right price you will find a buyer for anything. I was speaking to your point about liquidity, which is not about price of the asset, but about the quantity of interested buyers and the ease of structuring and executing a transaction with a buyer.

But there are buyers for complex financial instruments. There are many hedge funds around who can do both size and complex products. And other international banks have the teams and system to buy a portfolio.

But size is a problem. When you have 2 trillions $ of assets to sell, even if they are simple vanilla mortgages, it will be a buyer's market.

Future earnings are a multiple of current earnings. Any valuation in a multiple of current earnings... they're all numbers.

> but their value is generally a multiple of current earnings, not "a pure function of future earnings".

Not sure what your objection is. The function is something like V = 3 * r, where V is the value of the company and r is the annual revenue. Boom, pure function.

Well future annual revenue would be based on current, so it can't be considered pure

I like this framework.

I would term the difference "operating value", the extent to which the entity is valuable because of what it does vs what it owns.

Software companies are interesting because they fall in the middle, somewhat like banks.

Most banks are more in the middle than you might think. BofA for example, is valuable in large part due to its customer relationships and brand.

You're right that a pure holding company with no brand and "operations value" is just the book (accounting) value of its assets.

Reply on news.ycombinator.com