The comparable company analysis is an important valuation method that investment bankers use. This valuation method values a company based on market valuation multiples. The most commonly used multiple is price/earnings, which represents a company’s stock price divided by its earnings per share. Other relevant multiples you can use are the EBITDA multiple, revenue multiple, and sales multiple. Other things that you should also look at are risk and growth rates.
The analysis is relatively straightforward. You want to start off by selecting a large universe of comparable companies. You want to zero in on your peer group from here. After you have selected your peer group, do some research and find relevant financial information. Next, you want to spread key trading multiples, ratios, and statistics. After compiling all of the information, you can begin your analysis. Take the average and the median of the multiples of your peer group and use those for the company in question. By using the relevant multiples, you can determine the enterprise value of the company.
Since this methodology does include a control premium and relies on market-derived information, it will usually yield a more honest value. Bankers will usually compile a list of companies they feel are comparable and calculate the relevant multiples for each. The relevance of these multiples will vary from industry to industry. For example, the mining industry uses market capitalization to reserves. Other industries such as industrials will be compared using other multiples.
The peer group selected can include competitors and is selected by looking at factors such as industry, financials, and size. For example, if I were looking for peers for a soft drink manufacturer, I would look at similar sized companies and rule out smaller, less significant options. If there are not many competitors or industry participants, you should look for companies based on business model and size.
There are problems associated with this method. A main disadvantage of using the comparable company analysis method is the fact that you will never find a perfect match for your company. You will always be comparing apples to oranges so your value will never be exactly correct. Other problems include the market being skewed by current trends.
The comparable company valuation methodology will often give you a much lower valuation than other valuation methodologies like the precedent transactions method. It is great to use this method along with other methods to get an appropriate range of valuation for a company. Even with its problems, the comparable company analysis is still a great way to value a company.