Comparable Companies Analysis
A valuation based on comparable companies arrives at a valuation based on similar public companies in the target company’s peer group.
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Steps:
- Compile list of comparable companies
- Calculate relevant financial ratios
- Establish valuation range based on calculated multiples
- Apply valuation range to target company
- Apply a private company discount, if applicable
1. Compile list of comparable companies
- Comparable peer group should have relevant attributes:
- Industry group
- Business mix (products, markets served, distribution channels, etc)
- Geographic location
- Size (revenues, assets, market cap)
- Sources of comparable companies:
- Databases (e.g. Capital IQ, Factset, Hoover’s)
- Annual reports of target company
- Analyst / Industry reports
2. Calculate relevant financial ratios
Balance sheet items (e.g. Market Value and Enterprise Value) and Income Statement items (e.g. EBIT, EBITDA, Net Income) will be used to calculate relevant multiples used to arrive at a valuation
Equity Multiples
Certain flows apply to equity holders only, like net income & book value of equity. The balance sheet and income statement values are after the effect of debt. Hence, equity multiples are used to arrive at an equity valuation.
Relevant multiples:
- Price/Earnings (market equity value / net income to common shareholders)
- Price/Book (market equity value / book value of equity)
- Price/Cash Flow (market equity value / after-tax cash flow)
- PEG Ratio- measures growth prospects (PE Ratio / Annual EPS Growth)
- Enterprise multiples
- Other flows apply to all capital providers (debt & equity). The balance sheet and income statement values are before the effect of debt. Hence, enterprise multiples are used to arrive at an enterprise valuation.
Relevant multiples:
- Enterprise value/Sales
- Enterprise value/EBITDA
- Enterprise value/EBIT
Normalizing income statement items
Because the goal is to value the on-going business, income statement items (denominator) should be adjusted for one-time or non-recurring items. Non-recurring items should not be included in financials for valuation purposes (e.g. P&L statements, EBIT, EBITDA, Net income, etc).
Common examples include:
- Gain or loss on sale of divisions or real estate
- Legal settlements
- Asset write downs
- Restructuring charges
3. Establish valuation range based on calculated multiples
Once you’ve calculated relevant multiples for each company in the peer group, you can arrive at a valuation range using the following method:
- Calculate a median multiple
- Subtract one to get the lower limit of the range
- Add one to get the upper limit of the range
Example
The median peer group Enterprise/EBTIDA multiple is 6.0x. The lower limit of the range will be 5.0x (6 minus 1). The upper limit of the range will be 7.0x (6 plus 1).
Thus, your valuation range based on comparable companies is 5.0x – 7.0x.
4. Apply valuation range to target company
Let’s say that our target company has an EBITDA of $100 million. Applying the range in Step #3 above gives us a valuation range of $500 million to $700 million.
5. Apply a private company discount, if applicable
Public companies are typically considered more valuable than private companies for a number of reasons:
- Public companies are required to provide periodic, audited statements that adhere to GAAP. Private companies are not and often suffer from a lack of quality financial information.
- Public companies have a ready public market facilitating the purchase and sale of an interest in a public company, creating a liquid investment. This does not exist for private companies, making a private company investment relatively illiquid.
- Because public companies are typically larger than their private counterparts, the discount should take into account the size difference.
- Many professional apply a private company discount between 20% and 30%.
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