Valuation: Comparable Analysis

Trading Comparables (Public Comps)

Comparable company analysis (often called "trading comps" or "public comps") is a relative valuation method that determines the value of a company by comparing it to similar publicly traded companies. The fundamental principle is that similar companies should trade at similar valuation multiples. By identifying the right peer group and applying appropriate multiples, analysts can derive an implied valuation range for the target company.

Trading comps are the most widely used valuation methodology in equity research for several reasons: they are based on readily available market data, they reflect the market's current assessment of value, they are relatively easy to compute and explain, and they provide a market-based benchmark against which to compare DCF and other valuation approaches.

Steps in Comparable Company Analysis

1. Select the peer group: Identify companies that are similar in terms of industry, business model, size, growth rate, profitability, and risk profile. This is the most critical and subjective step in the process.
2. Gather financial data: Collect current share prices, shares outstanding, net debt, and financial metrics (revenue, EBITDA, net income, EPS) for the peer group. Use both historical (trailing twelve months, or TTM) and projected (next twelve months, or NTM) data.
3. Calculate valuation multiples: Compute relevant multiples for each peer company, including both enterprise value-based and equity value-based multiples.
4. Determine the appropriate multiple range: Analyze the distribution of peer multiples and select the relevant range (typically the median or interquartile range). Exclude outliers that may distort the analysis.
5. Apply the multiples: Multiply the target company's financial metric by the selected peer multiple to derive an implied valuation range.

Key Valuation Multiples

Enterprise Value-Based Multiples

EV/EBITDA is the most widely used enterprise value multiple. It measures the total value of the business relative to its operating cash earnings. EV/EBITDA is capital structure-neutral (because both numerator and denominator are pre-debt) and unaffected by differences in depreciation policies. Typical ranges vary widely by industry: mature industrials may trade at 8-12x, high-growth technology companies at 15-30x or higher, and utilities at 6-9x.

EV/Revenue (also called EV/Sales) is used when a company is unprofitable or when revenue is considered the most reliable metric. It is commonly applied to early-stage growth companies, SaaS businesses, and companies undergoing restructuring. The limitation of EV/Revenue is that it ignores profitability entirely — two companies with the same revenue but vastly different margins should not be valued at the same multiple.

EV/EBIT is similar to EV/EBITDA but accounts for depreciation and amortization. It is preferred when comparing companies with significantly different capital intensity, as it captures the economic cost of asset usage that EBITDA ignores.

Equity Value-Based Multiples

Price/Earnings (P/E) is the most widely quoted equity valuation multiple. It divides the share price by earnings per share (EPS). P/E is intuitive and widely understood, but it has significant limitations: it is distorted by differences in capital structure (leverage), tax rates, and non-recurring items. P/E is most useful for comparing companies with similar leverage profiles and tax situations.

Price/Book (P/B) compares the market value of equity to its book value (shareholders' equity). P/B is commonly used for financial institutions (banks, insurance companies) where book value is a meaningful indicator of the asset base. A P/B ratio above 1.0 indicates the market values the company above its accounting book value, reflecting expected future profitability.

PEG Ratio = P/E / Expected EPS Growth Rate. The PEG ratio adjusts P/E for growth, making it useful for comparing companies with different growth rates. A PEG of 1.0 is sometimes considered "fair value," though this rule of thumb has significant limitations.

Peer Group Selection

The quality of a comparable company analysis depends critically on the quality of the peer group selection. An improperly selected peer group will produce misleading multiples and unreliable valuations. Analysts should consider the following criteria when building a peer group:

• Industry and sub-industry: Companies in the same industry face similar market dynamics, competitive pressures, and regulatory environments. Sub-industry classification matters — a cloud software company should not be compared to a hardware manufacturer, even though both are in "technology."
• Business model: Companies should have similar business models in terms of revenue composition (recurring vs. non-recurring), customer type (B2B vs. B2C), and geographic focus (domestic vs. international).
• Size: Larger companies often trade at premium multiples due to greater liquidity, diversification, and perceived stability. Comparing a $50 billion large-cap to a $500 million small-cap may not be meaningful.
• Growth profile: Companies with higher expected growth rates typically command higher multiples. A peer group should include companies with similar growth trajectories.
• Profitability: Companies with higher margins and returns on capital tend to trade at higher multiples. Margin differences should be acknowledged when interpreting comp data.
• Geographic market: Companies operating in different geographies may have different growth opportunities, risk profiles, and tax rates.

Precedent Transaction Analysis (Transaction Comps)

Precedent transaction analysis (also called "transaction comps" or "deal comps") values a company by examining the prices paid in comparable M&A transactions. Rather than looking at how similar companies are currently trading in the public market, this method examines what acquirers have actually paid to buy similar companies.

Transaction multiples typically include a control premium — the additional amount above the trading price that an acquirer pays to gain control of the target company. Control premiums typically range from 20-40% above the unaffected share price, reflecting the value of controlling the target's strategy, operations, and cash flows, as well as expected synergies.

Key Steps in Precedent Transaction Analysis

1. Identify relevant transactions: Screen for M&A transactions involving companies similar to the target in terms of industry, size, and business model. Focus on recent transactions (typically within the last 3-5 years) to reflect current market conditions.
2. Gather transaction data: Collect the deal value (enterprise value paid), financial metrics of the target at the time of the deal, and any disclosed synergy estimates.
3. Calculate implied multiples: Compute EV/EBITDA, EV/Revenue, and other relevant multiples implied by the transaction price.
4. Analyze and adjust: Consider the circumstances of each deal (strategic vs. financial buyer, competitive auction vs. negotiated deal, market conditions at the time).
5. Apply to the target: Use the relevant range of transaction multiples to derive an implied valuation for the target company.

Enterprise Value Calculation

Correctly calculating enterprise value is essential for computing EV-based multiples. Enterprise value represents the total value of the business to all capital providers and is calculated as:

Enterprise Value = Market Capitalization + Total Debt + Preferred Stock + Minority Interest - Cash and Cash Equivalents

Understanding why each component is included or excluded is critical:

• Market Capitalization (Equity Value): The market value of common equity = share price x diluted shares outstanding. Use the treasury stock method for in-the-money options and warrants.
• Total Debt: Added because an acquirer would assume the company's debt obligations. Debt includes short-term borrowings, long-term debt, capital leases, and any other interest-bearing liabilities.
• Preferred Stock: Added because preferred shareholders have a senior claim to equity holders and must be compensated in any change of control.
• Minority Interest: Added because EV-based metrics (EBITDA, Revenue) include 100% of consolidated subsidiaries' financial results, so the value must include the minority owners' share.
• Cash and Cash Equivalents: Subtracted because an acquirer would receive the company's cash balance, effectively reducing the net cost of the acquisition.