Valuation of Banks

How do you value a financial service firm? We would like to value financial service firms, just as we value other firms, using expected cash flows to equity (since leverage at banks is usually high and fairly stable). The problem we run into is that cash flows at a bank are not easily estimated. Neither net capital expenditures not working capital are well defined, and banks expense many items (such as training expenses) that can be viewed as the equivalent of capital expenditures. Given these difficulties in estimating cash flows, we are often stuck with the dividend discount model as a model of last resort. For banks that choose not to pay dividends or pay less than they can afford to, the potential dividends can be estimated using the expected growth rate and the return on equity. Potential Dividend Payout ratio = 1 - g / ROE