Comparable analysis helps you figure out what a company is worth by looking at the value of similar companies with similar attributes.
Before we dive in more, remember the last time you were looking for a place to live. You probably looked at multiple listings, comparing location, the number and size of bedrooms, the number of bathrooms, and the size of the kitchen with a goal of finding what a fair price for a house of a certain size in a certain location should be. This is an example of a comparable analysis.
Just like comparing the houses, comparable analysis helps you compare different companies to figure out what you should pay for a company with similar attributes. Instead of looking for how many bathrooms it has, you are going to focus on looking at the products / services it sells, who the customers are, where the company is located, if it operates locally or globally, etc.
Once you find enough similar companies, you can start comparing their performance.
When performing public company comparables (aka comps), analysts are looking for companies that fit the description of the company they are trying to derive value for. They try to find companies that are similar in size, companies in the same industry, and companies that have similar business characteristics in terms of growth, profitability and risk. There are many multiples that may be used, but they all compare some aspect of company’s internal measurement to the company’s value (e.g. share price/earnings, total enterprise value/EBITDA, etc.).
It is important to note that ratios vary from industry to industry because different industries typically have unique margins, capital structures and other important business aspects. This means that it is not optimal to compare ratios from two different industries (e.g. finance vs. tech). Additionally, some companies, even if comparable, may have higher multiples (e.g. because of faster growth).
- Reflects value according to current market trends
- Provides a benchmark value based on other similar companies
- Industry trends and growth prospects are accounted for
- Hard to find comparable companies (every company is different)
- Does not account for the premiums that are paid in M&A transactions
- Doesn’t explain market inefficiencies
Imagine reselling a rare painting from a famous painter. If you wanted to figure out what you could sell it for, you’d probably look for other similar transactions to get a sense for the correct price of your painting.
A transaction comparables analysis looks at the values (prices) that were paid for companies that are similar to the one you’re trying to value.
It is similar to public company comparables in terms of using different ratios to find the value. However, comparable transactions include acquisition premiums.
This means that the valuation includes the difference between what the company was worth and what it was paid for it in the transaction.
For example, imagine that the company has EBITDA of $20 million and the market is valuing it at 5.0x EBITDA (5 x $20 = $100 million). However, in order to incentivize the owner of the company to sell it to me, I have to pay $120 million, or 6.0x EBITDA ($120 / $20 = 6.0x). The difference between the original value ($100 million; 5.0x EBITDA) and the value I paid ($120 million; 6.0x EBITDA) is called acquisition premium.
As the example above shows, transaction comps will generally result in the higher value than company comparables.
How to do it?
- Identify comparable (similar) companies
- Select appropriate multiples
- Gather data to calculate the multiples
- Calculate multiples for each company
- Gather multiples across the comparables set and summarize them in a High-Mean-Median-Low table
- Use the multiples to derive target company’s value
- EV / Revenue
- EV / EBITDA
- EV / EBIT
- EV / Free Cash Flows
- Price / Earnings
- Price / Book