Comparable Company Analysis Overview
There are multiple methods investment bankers and other financial analysts use to value a company. One frequently employed relative value method is comparable company analysis. Comparable company analysis is especially useful when valuing the minority, non-controlling interest of a company.
Theoretical Basis
Comparable company analysis is rooted in the idea that companies with similar characteristics should have similar valuation multiples. Typically, a group of comparable companies includes companies from the same industry as the company being valued and companies with similar fundamental characteristics.
Multiples Valuation
After identifying the list of comparable companies, the comparable valuation multiples are applied to the company being valued to establish a relative valuation. Common valuation multiples include price to earnings, price to book, and enterprise value to EBITDA ratios. For example, the mean or media price to earnings ratio of the comparable companies would be multiplied by the earnings of the company being valued to establish a relative valuation. By valuing the company using many multiples, a relative value range is established.
Benefits
A key benefit of comparable companies analysis is that the methodology is based on the current market stock price. The current stock price is generally viewed as one of the best valuation metrics because markets are considered somewhat efficient. Also, because comparable company analysis is based on stock prices, the technique is especially useful for valuing potential IPOs.
Drawbacks
Finding true comparable companies that closely resemble the company being valued can be difficult. In addition, comparable multiples based on small companies that are less liquid in public markets provide less reliable valuation metrics. Another drawback is that comparable company analysis only values a minority, non-controlling interest in a company, which is less useful for acquisition valuations.
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