Valuation
Financial valuation is a complex topic on which many great minds have opined. Starting your education with Warren Buffett's Intelligent Investor, McKinsey's guide on Valuation, or Aswath Damodaran's well known blog are all great places to understand both academic and pragamatic points.
That said, investment bankers focus their valuation efforts on three key methods: comparable companies analysis, comparable transactions analysis and the discounted cash flow analysis. There are some other relevant analyses worth touching upon including a leveraged buyout analysis and M&A combination analysis.
Comparable Companies
When buying stocks, a common ratio that investors refer to is a price to earnings ratio (P/E). It simply compares the price of a share of stock to the net earnings per share of that company.
Ratios such as P/E enable bankers and their clients to compare the relative quality of one company versus another. If companies exhibit stronger fundamentals such as better competitive moats, more effective management teams or participating in more attractive industries, we expect these firms' stocks to trade at higher valuation ratios such as P/E. Other common ratios include EV/revenue, EV/EBITDA and EV/uFCF.
Comparable Transactions
If you have ever bought a house, you have seen comparable transactions. Typically, houses in the US sell on a price/sq ft multiple so a buyer can compare several houses sold in the same neighborhood even if their prices or number of bedrooms are different. The same approach works well for companies previous sold.
The key to precedent transactions, as this analysis is also called, is to identify the most relevant transactions (choose grocery stores vs. broader retail if you're acquiring a grocery store chain), select an appropriate timeframe (tricky these days to choose pre-Covid transactions in certain industries) and determine why the current transaction deserves a premium/discount to the comparable deals. The seller will naturally argue for a premium and the buyer may select alternative deals to justify a discount.
Discounted Cash Flows
The DCF is the mother-of-all valuation approaches. The objective is to determine the intrinsic value of a business by calculating the present value of future cash flows. Both finance academics and practitioners subscribe to this methodology. However the challenge is trifold: developing an objective cash flow forecast, selecting an appropriate discount rate, and determining a fair terminal value. Given these difficulties, the approach is always in the banker's toolbag but more often used to consider a 'fair value' than the bid/ask in an M&A transaction or IPO.
Modeling
Financial modeling is a broad and complex topic with practitioners ranging from entrepreneurs to public company CFOs to mutual fund investors. Our focus here is on investment banking models, both their purpose and how they look in practice. Investment bankers typically use financial models to understand the forecasted outlook for companies and the expected valuation of a company based on those forecasts. Furthermore, bankers use models to analyze the combination of two companies in a merger or understand the feasibility of financing an acquisition.
Financial Forecasts
Given that bankers are advisors to clients who typically manage or invest in businesses professionally, bankers prefer to rely on the financial forecasts provided by their clients or on consensus Wall Street research analyst projections. Forecasts are generally provided on a quarterly basis in the near-term and on an annual basis over a longer period of 3-5 years. Forecasts consist of line items including revenue, profit margins, interest and taxes and often are supplemented by cash flow items such as working capital, capital expenditures and depreciation. Importantly, bankers tend to use 'non-GAAP' financials, which means that the forecasts are adjusted to add back non-recurring and non-cash items. While shrewd investors such as Warren Buffett may disagree, the idea is to normalize our future view of the business.
Merger Combination Analyses
In a merger or acquisition, there are several common analyses beyond the standalone valuation of the target that are used to justify a transaction from a financial perspective. An accretion/dilution analysis is common in mergers between two public companies. The analysis sums the net income of the two companies and divides by the final shares outstanding and compares is amount to the acquirer's initial earnings per share. In an all cash deal, the share count will remain constant and the pro forma earnings will be reduced by the interest expense to finance the deal. In a transaction partially funded by equity, the share count will increase from new share issuance.
The other common analysis is an assessment of synergies. Both revenue and cost synergies from combining two companies are considered, however cost synergies are most relied upon and evaluated across both cost of sales and operating expenses. A synergy analysis can be done for a private transaction, but in a public transaction, it can be combined with an accretion/dilution analysis to understand what synergies would be required for a transaction to be breakeven from an accretion/dilution perspective.
Recruiting and Interviews
Interviews in investment banking vary by bank, group, function and geography. That said, here are some standard practices that undergraduate and MBA students at core schools will see across the board. For MBAs, recruiting begins when students come to campus, and arguably before, if students participate in diversity programs offered by banks in the summer before school starts.
On Campus Recruiting
At so-called 'core' undergraduate and MBA programs, investment banks will visit campus to deliver an initial presentation and return in subsequent weeks for follow-up recruiting events, which are either open or closed, invitation-only, often later in the process. Large bulge bracket banks tend to visit all major business programs, and boutique and middle market/regional banks will limit their focus to certain geographies.
In addition to the events, aspiring bankers are expected to set up 'coffee chats' with bankers, which are often phone/Zoom calls or office visits where they introduce themselves and ask basic questions about the bank and banker with whom they're speaking.
Some banks take a 'high touch' approach to recruiting with as many as 4-7 events and a double-digit number of coffee chats expected while other 'lower touch' firms may decide on potential interviewees after 1-2 events and ~5 coffee chats with the relevant associates/VPs running a particular recruiting process.
In most cases, the campus recruiting process completes with 'bank week', often at firms' HQs in Manhattan where senior banker alumnus present to students, and recruits often finalize their geography and industry/product group decisions.
Interviews
Every year, the interview process for both undergraduate and MBA student internships starts earlier than before. Undergraduates in their sophomore year are already seeking sophomore summer internships, which then better position them for junior summer internships. MBA students are sometimes protected by their schools, which prevent firms from arriving to campus too early (and presumably before students have decided to recruit for banking).
First round interviews often take place virtually (the on campus and in hotel room days are largely behind us) and use software such as HireVue to attempt to more evenhandedly rate recruits. Final rounds generally take place on-site at firm offices and are often in a 'Super Day' format with 4-6 consecutive interviews that test behavioral, fit and technical skills. Banking analyst interviews still take the cake for the most technical and some firms will even have written assessments to test candidate abilities.
Internship
Investment banking internships are typically 8-12 week interviews regardless of the firm, location or group. Junior bankers are eager to reduce their workload by pushing it onto enterprising interns, and senior bankers are largely focused on the top few candidates whom they know they will have to sell to join at the end of the summer (vs. re-recruiting for more prestigious firms).
In the post-Covid world, the first week of training is typically on site as opposed to at a global HQ as it sometimes was in the past. The first week consists of classroom type training on software tools, processes, analyses/modeling and making pitchbooks. The following weeks consist of joining deal teams, and experiences vary widely.
If recruits are joining during a summer with significant deal activity, they may find themselves on multiple deal teams and creating client deliverables from the first day on the desk. During a slower summer, they may spend more of the summer on business development pitches, industry overviews or even internal planning materials (hopefully not!). Lastly, many groups require interns to complete a summer project in addition to their deal work - this approach is used to ensure that students are able to handle the modeling, pitchbook and presentation parts of the job individually.
In the middle of the summer, there is a standard check-in with the intern staffer or team COO with clear feedback on if a candidate is on track to receive an offer. Sometimes HR/recruiting participates in these sessions as well. At the end of the summer, each intern has a formal review and is either offered a full time position or is not, and in rare occasions, they might be offered a position in the firm but not in the specific group where they interned. At this moment, the intern finally holds some power over the firm with the ultimate decision of whether to return. However, firms typically offer additional signing bonuses to encourage recruits to sign as soon as possible (closing the deal!).