By Victor Paquet (Mergersight Operations) and Carlo Lepoardi & Tommaso Arona (Boston University partners)
Comparable companies analysis is one of the primary methods used for valuing a company or asset. It uses a peer group of publicly traded companies to set a market benchmark against which a banker can establish a relative valuation for a private company or analyze the value of a publicly traded company. This will help determine whether a company is under/overvalued in the market relative to its peers. As it is one of the various valuation methods used, it is typically used as a sanity check after other intrinsic valuation methods are used (i.e: DCF analysis which we covered).
3 steps of a Trading Comps analysis:
Select the peer group (or “comparables universe”)
Spread key statistics, ratios and trading multiples
Out of the group, find the Min & Max, 1st & 3rd quartiles, Median and Average values to derive a valuation range
Step 1 - Select the peers
Aim to pick about 5-10 companies whose financial statements or key metrics are accessible using public fillings or financial advisory databases (e.g. SEC fillings, Yahoo Finance, Capital IQ, Bloomberg).
These companies should come as close as possible to your target in terms of size, industry, geographical location,business model, business maturity, growth rate, and products/services offered. This is important as the comparable companies analysis will not be accurate if you are comparing unrelated data points from vastly different businesses. You should view it as comparing things on an “Apples to Apples” basis.
You might also need to create various different peer groups if your company has various business segments (e.g. Amazon might have cloud services, E-commerce, pharmaceutical, tech, and digital streaming peers.).
Step 2 - Spread Key Stats
A trading multiple is a financial metric that uses a specific financial or operational measure of a company and compares it to its market price (expressed as a ratio).
Key drivers of trading multiples: growth and margins, along with the current macro environment. Find the Last Twelve Month (LTM), sometimes called Trailing Twelve Months (TTM), trading multiples for each peer.
The two most commonly used trading multiples are EV / EBITDA and P/E, while EV / Revenue is commonly used for fast-growing businesses who are not profitable yet.
EV = Entreprise Value
EBITDA = Earnings Before Interest, Tax, Depreciation, & Amortization
P = Price per Share
E = Earnings per Share
Step 3 - The Valuation Range
Out of the peer group, find the minimum, 1st quartile, average, median, 3rd quartile, and the maximum. A typical comparable companies analysis will apply the median of the peer group to the target’s financials. The median is typically used rather than the average as it excludes outliers.