How do you value a wealth management practice?

Well, what are the features of the business you can look at? Here are a few thoughts:

A) AUM B) Net income/net revenues C) Other qualitative measures.

To answer your question:

1) How do you value a wealth management practice? >As a value investor, I would start with an industry earnings multiple and make adjustments for the quality of the revenues and the business (A and C).

2.) What do you use as the discount rate?

>This is a silly question, IMO. Why do we need to start with the discount rate to get the firm's value? That's a really complicated place to start, because it involves guessing future earnings- something Wall Street can't really predict more than a year or two out- and is always subject to massive unknowns about the economy and unknowns about the inadvertent biases of the mean earnings prediction. Let's take a look instead at the average industry P/E first and figure out what's a good relative value, which is a lot easier, and then figure out how those earnings will improve/disimprove relative to the rest of the market.

So to answer your question, the discount rate we would use is the same that everyone else on Wall Street is using for wealth management businesses- with some adjustments in rare cases if managers are switching or there are other unusual business risks that wouldn't apply as much to other wealth management firms.

"But what if the firm is losing money?" complains the interviewer- in that case, you figure out what they expect to be making in the future and apply a larger discount to the P/E to add a level of skepticism and safety margin in addition to the fact that they're future earnings. If the interviewer insists, yes, you can back out an appropriate discount rate at this point- if you're in a rush, treat the average wealth management firm as a roughly inflation-indexed perpetuity, divide 100% by the average P/E, tack on expected inflation or expected "net investment growth rate" if you have a measure like that, and bam- that's a quick and dirty discount rate to apply in addition to your margin of skepticism. If they're never going to make any money, well, then the firm should close up shop now and it's worth its liquidation value.

This answer might piss the interviewer off, but you've covered nearly every angle on it. A wealth management firm is really worth its earnings plus whatever net equity it doesn't need for its business. That's all.

3.) What would be an acceptable range for the value of a wealth management firm with 100 million AUM and 1-2% fees

>First, you need to know what the firm's costs are. Second, can investors get better performance for a 1-2% management fee elsewhere? Finally, is it safe to assume the firm is similarly capitalized compared to everyone else in the industry- they don't have any extra equity just sitting around unused or abnormal levels of liabilities? If the expenses are sustainable at that level and the revenues are sustainable, you figure out an applicable P/E for the applicable net income and therefore a price and then tack on any equity that is not required for the asset management business, and you've got a price.

This is just coming from the perspective of a simple value investor. A P/E shop, trader, growth investor, or someone else might employ completely different methodology, but this might be a good place to start. It's an annoyingly simple methodology in a field that's a terribly inexact science, and IMHO, it's as good as any other method- it's just a lot easier to use and harder to MASSIVELY screw up like some of the other methods.