In 2024, the financial services industry experienced notable shifts in market activity, mergers and acquisitions (M&A), and company valuations compared to previous years.

In the U.S., stable interest rates and improved economic conditions contributed to a positive outlook for big banks.

The Federal Reserve’s indication of limited interest rate cuts maintained higher net interest margins, supporting profitability.

Analysts anticipated revenue growth across most divisions of top banks, positioning them for strong performance.

The financial services sector saw a resurgence in M&A activity. This surge was driven by factors such as a stable political climate, abundant private equity reserves, and companies seeking scale through mergers.

The wealth management sector experienced record M&A activities among registered investment advisors. Increased consolidation trend shows enhanced service offerings and expanded advisor networks to come.

The political landscape influenced expectations of regulatory changes impacting the financial sector. The potential for eased regulations, such as the rollback of Basel III rules, suggested a more favorable environment for bank mergers and increased lending activities.

Financial institutions continued to integrate AI and fintech solutions to enhance operational efficiency and customer experience. Companies like Stripe expanded AI integration in cross-border payments and fraud prevention, contributing to valuation recoveries in the fintech sector.

Overall, 2024 marked a year of significant activity and transformation in the financial services industry, with increased M&A activity, improved market performance, and strategic adaptations to evolving regulatory and technological landscapes.

Financial Services Valuation Multiples

Out of 243 companies, the last row in the below table shows the median valuation multiples for diversified financial services companies as of September 30, 2024 and last twelve month data.

Compared to the median valuation multiples in 2023, there were some multiples that increased and some decreased:

• Median Price-to-Sales (P/S) Multiple decreased from 3.3x to 3.0x.
• Median Price-to-Book Value (P/BV) Multiple increased from 1.0x to 1.5x.
• Median Price-to-Earnings (P/E) ratio increased from 9.4x to 12.8x.
• Median Return on Equity (ROE) increased from 10% to 13%.
• Median Dividend Yield remained steady at 4%.

What does this mean? Let’s unpack possible explanations.

• A lower P/S ratio suggests that revenue grew faster than the stock price. This can mean that revenue grew but investors don’t have high expectations that the revenue growth will be sustained into the future, so they don’t attribute a higher valuation on the stock price.
• Meanwhile, P/BV ratio increased, which means that the stock price grew faster than the book value or that the book value shrank relative to revenue. This suggests that book value may have declined due to 1) lower profitability due to higher operational costs, 2) there were write-offs such as from loan impairments, or 3) there were capital distributions, such as dividends or buybacks that were higher than usual. Note that dividend yield remained the same, so we can rule that it was not due to higher dividends.
• At the same time, ROE increased. This means net income was higher than the book value in comparison to last year. What this indicates is that profitability has improved. So, out of the 3 primary reasons for a lower BV which led to a higher P/BV ratio, it is not likely that the reason was due to lower profitability and it is not likely that it was due to higher dividend payout.
• Then could it be due to higher loan impairments that resulted in a lower BV? In fact, there are some facts that point us to this reason. According to Financial Times and Investec as reported by Reuters, 2024 had the highest loan default rate in the last 4 years since the pandemic.
• Despite a lower BV, the P/BV has increased. Putting it together with a decline in P/S, this suggests that investors are putting more weight in the financial services firms’ expected profitability and earnings growth more than revenue growth. In other words, investors don’t expect higher revenue growth, but they do expect higher profitability and earnings growth. And this supports the historical trend that financial services firms are not typically known to be fast or high revenue growth industry YoY.

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