• Saahil Menon

Talking Stocks: SVB Financial Group

Updated: Feb 8, 2020

Although big financiers shy away from the unpredictable winds of startups, Silicon Valley Bank audaciously grab their deep pockets and sail straight into the storm.

Despite being a more under-the-radar bank, the potential that this company possesses is certainly one that you want to be part of if you’re aiming to be a profitable investor, and the evidence behind why is detailed below.

Without further ado, here the merits behind why Silicon Valley Bank is a BUY for me, and why it'll continue to be so in the near future:

1. Strong Financials

Considering the fairly young age of the bank as well as the fact that it solely caters to one niche (technology startups, which require a substantial amount of capital), the financials of this corporation are incredibly favorable. Specifically consider these three aspects:

  • 5-Year Net Profit Growth:

In the last five years, SVB Financial Group have stimulated their net profits to boast a 30.79% average increase per year, which significantly surpasses the 19.80% industry average. This suggests that gross profits and expenses are being managed extremely well, even through periods of low interest rates, when most banks tend to begin losing revenue.

Moreover, the uniqueness of SVB lies in the fact that they cater to a small niche, but it’s a niche that’s proven to produce companies with tremendous success. They benefit from this because their focus is streamlined – as their operations and staff are catered to one industry – which puts them in the driver’s seat to gaining clients as they’ll be far more desirable as a financing partner than banks without tech startup expertise.

This is especially significant because, according to Inc.com, niche-targeted Financial Services companies are the second-best performing businesses in terms of revenue as of 2017 onwards. The fact that SVB have managed to create a strong brand in such a profitable niche suggests that they are on the right path to retaining high cash inflows and financial stability in the foreseeable future.

  • 5-Year Sales Growth:

Similarly, SVB’s sales growth over the last half-decade significantly implicate strong fundamentals by once more obliterating industry performances. Here, sales for the company have been ameliorating at an average of 21.97% per year, compared to a mere 0.37% growth in the industry as a whole.

This level of substantial growth can be attributed to the growing number of tech startups entering the market each year, as implicated below.

Concisely shown in the graphosemantics above, the start-up industry is expanding each year, and with more companies comes the need for much more funding. This is where financiers such as SVB enter the picture and benefit from start-up’s desperation for funding, because they are able to provide it specifically to tech companies and gain handsome profits in return.

Depending on how many tech startups continue to enter and are actually successful, this type of business model will prove to be continually profitable for SVB. In contrast, if the number of startups in the market begin to decrease (as indicated in the latter stages of the rightward graph), this could potentially pose a risk to the profitability of the company. Fortunately for this case, the graph refers to global deals whereas SVB finance companies only in the US, which is why the bank will be content as long as the number of start up deals in their specific market grows.

If the advent of more startups perpetuates, then SVB's profitable involvement certainly does look like a positive bet for the future.

  • Debt to Equity Ratio:

A pervasive commonality between tech start-ups is debt. This usually occurs because startup owners love the retention of their control as well as the fact that people aren’t exactly open to investing in new, potentially unreliable businesses: i.e. this is why over 85% of startups are financed through debt.

While borrowing funds is common among SVB’s clientele, it’s certainly not a case for themselves. For every $1 SVB borrow, they have over $7.70 in equity (Debt-Equity ratio of 12.99%), which means that they can easily meet their financial obligations, regardless of whether it's short term or long term. This greatly outperforms the industry D-E ratio of 190%, which is a staggering statistic as every $1 earned by SVB’s competitors requires the borrowing of $1.90 - their liability is almost double!

Therefore, the fact that SVB Financial Group are quite profitable with hardly any debt in their war-chest once more speaks to the financial stability of this company, and depicts that SVB's management are using their funds intelligently compared to their competitors.

2. A niche facilitates strong relationships that can be leveraged over time.

The fact that SVB cater to such a small category of firms brings upon advantages that big financiers may not be able to benefit from.

For example, financing small tech companies facilitates strong relationships with owners and senior staff given the lengths of time that are spent discussing loan amounts and transactional advisory: both of which allow the manifestation of trust and corporate reliance. While these two aspects may not seem all that important, in the long run, leveraging good relationships is the key to repeat purchases and potentially increased clientele (through word-of-mouth): hence placing SVB on an optimal trajectory towards financial success.

Statistically, this can be evidenced through research conducted by established consultancy firms such as Bain & Co. and the Garter Group. In the former’s research, results depicted that “a 5% increase in customer retention can increase a company’s profitability by 75%” , which undoubtedly depicts the impactful nature of solid customer relations and repeat purchases. Additionally, consider the latter’s research, which found that “80% of a company’s future revenue comes from just 20% of their existing customers.”, another staggering fact that articulates the potential profitability for a business that can be the go-to lifeline in a market.

Both statistics pose a clear and concise picture that advertises the monetary benefits of positive corporate relations. Since SVB undoubtedly check this box, its yet another indicator of their trajectory towards financial stability in the long term.

3. SVB Stock is currently undervalued:

This is perhaps strongest quantitative reason to buy this equity NOW and significantly profit from it down the line, and it’s a key indicator used by the most successful modern-day investors on a continual basis.

There's a norm in the investing community which states that “the secret to profitable investing is figuring out the value of something... and essentially paying a lot less for it”. Taking this under consideration, we can see below that SVB shares are undervalued by a cosmic margin, which might prove to be the optimal time to pounce in:

Note: There are several processes towards obtaining this value, such as calculating the book value or deriving the present value of future cash flows. The book value refers to the sum of all assets, minus liabilities, minus preferred stock, all divided by total shares outstanding. On the other hand, the present value’s calculation is slightly more complex and involves a great deal of financial esotericism, which is why its explanation was avoided in order to keep beginner investors intrigued. For more information on the calculations, click the link on the image above.

Nevertheless, using either of the methods described above brings upon an intrinsic value of $404.60 per share, whereas the current price of SVB is only $224.01. This goes to show you that SVB are currently undervalued by almost 45% at the moment, which suggests – based on their assets – that their scope for financial growth is substantial the near future.

This process of picking stocks that are undervalued and significantly profiting from their subsequent rise is known as value investing, and it’s precisely what created the immense wealth of legends such as Warren Buffet, Charlie Munger and Seth Klarman.

While there are many more undervalued stocks to benefit from, SVB's fundamentals clearly point to sizeable growth in the long term, which is why I believe that investing while their stock is still trading at a discount to its underlying value is likely to generate substantial returns in the near future.

Overall Sentiment:

Although a shorter analysis than usual, the implications above undoubtedly depict SVB’s potential on both the quantitative and qualitative fronts.

The data within their financial documents brings upon incredibly impressive ratios that far outweigh the industry performance, and suggest a profitable future for the company if current management is upheld. Additionally, the financial outlook on the firm is further ameliorated because the stock price is clearly undervalued, which articulates the fact that their assets are currently trading at a discount to what they’re worth. In the long term, if more managers and investors begin to see this, the share price may augment accordingly until it reaches, or perhaps even exceeds, it’s actual value.

Considering the quantitative side of SVB, the fundamentals point to a successful and profitable future.

In terms of qualitative prospects, SVB’s niche industry and strong client relations pose advantages for the long term, as the bank could benefit from large cash inflows from existing clients, as well as new revenue from other tech start-ups looking to find a corporate leg to stand on.

Regarding the profitability of an investment into SVB, significant risks are the current macroeconomic affairs that directly influence investor sentiment. If the US-China trade war continues or interest rates greatly decrease, the lack of business and investor confidence will inhibit the growth that we envision for the SVB Financial Group.

Other than these aforementioned indicators, the financials, clientele, and overall growth in tech/internet-related startups suggest a bright future for SVB, and concomitantly, for the investors who soon open a position on this profitable stock.