Hi Yasar,

There are significant no. of fund managers/banks using the Residual Income approach. Its actually not specific to any bank but the kind of company you are valuing.

If the EPS is negative for a year the you would have the negative residual income that year however it shall not affect the valuation as one year residual income is a small part of valuation. As per the Residual Income approach.

Value of The company (V) = Current Book Value (BV) + Sum of discounted residual income till perpetuity

Benefit of this method is that your valuation is not very sensitive to the Terminal value (Which is a significantly large portion of your FCFF Model) How ever the draw back is that your valuation is vulnerable to get affected from accounting irregularities.

The approach is used for Banking Sector as the Book value of a bank is close to the market value unlike a manufacturing firm (where the book value is outdated)


Priyank Jain