Learn about the concept of the Comparable Company Analysis in Detail

If you are an investor and are thinking of investing money in an organisation and want to know its worth, then you must thoroughly understand the concept of comparable company analysis and we will help you understand the same in a more detailed manner. So, let’s move ahead with this. 

Introduction to Comparable Company Analysis 

The concept of the Comparable Company Analysis is the process that is used for the evaluation of the value of a company by using the metrics of the other businesses working in the same industry and even of the same size. This method of the Comparable Company Analysis works under the regime by taking an assumption that the similar companies have the similar valuation multiples, for instance, EV/EBITDA. 

Taking into consideration the company valuation ratio helps determine whether the company is overvalued or undervalued. If the ratio is low, then it can be assumed that the company is undervalued and if the ratio is high, then it can be assumed that the company is overvalued. 

The common valuation measures that are used in the Comparable Company Analysis method are the Price to Earnings (P/E), Price to Book (P/B), Price to Sales (P/S) and Enterprise Value to Sales (EV/S). 

What is the importance of the method of Comparable Company Analysis? 

The method of the Comparable Company Analysis is chosen widely by the investors as it is very easy and convenient to use and the data required for the purpose of the valuation is widely available (though the advantages of the method are widely discussed in the below-mentioned parts).

This is why this method is widely applicable to publicly traded public companies. In this method, it is assumed that the market is pricing the securities of others efficiently and the companies give a good range of the valuation while the other methods such as the discounted cash flow is based on a long list of assumptions. 

By whom is the Comparable Company Analysis Method used? 

As we have rightly discussed the importance of the Comparable Company Analysis Method and due to the fact that these factors combinedly contribute to make it the best method. This method is widely used by the:

• Private Equity Investors
• Investment Bankers
• Research Analysts

Methodologies beyond Numbers 

The method of the Comparable Company Analysis is not about the numbers, but instead, it is about the story behind the data. The analysts assess a lot of factors that include both quantitative and qualitative for arriving at meaningful conclusions. The Quantitative aspects include revenue figures, profit margins, and multiple earnings, thereby providing the quantitative foundation for the valuation.

The Qualitative factors include brand reputation, management quality, and the competitive positioning, which adds depth to the analysis. Therefore, it can be summed up that this approach is helpful in capturing the intangible and tangible aspects of the business. 

What are the key factors included in the Comparable Company Analysis? 

• Operational Data: The understanding of the Operational Data of the company, which includes the market share compared to the competitors that provides the information related to the competitive position of the company. Analysing the operational data of the company also includes analysing its customer demographic and the loyalty of the customers to help in assessing the customer relationship of the company. Lastly, evaluate the process of the reach of the products or services to the customers. 

• Sector and the Industry: The analysts take into consideration the type of the industry, its growth prospects and its stability impacting the valuation. Apart from the industry analysis, understanding of the current market trends and the projected predictions within the specific sector. 

• Financial Positioning: The financial positioning, in its first instance, involves the evaluation of the revenue figures of the target company. Assessing the net profit margins and operating margins provides insights related to the profitability of the company. 

• Prospects of the Growth: Analysing the past performance of the company helps in understanding the projected future performance of the company. Also, analysing the Research and Development Expenditure provides an indication about the potential and the future development of the products or services. 

• Scale and Size: As the methodology of the Comparable Company Analysis is totally based upon taking into consideration the similar business sizes as it ensures into a fair valuation of the target company. 

• Geographic Location: Analysing the Geographic and international market and comparing them with similar companies provides a good insight into the market diversification. 

• Risk Factors: There are two types of risk factors that must be taken into consideration and these are volatility and debt levels, as the less volatile companies receive higher valuations. Volatility ensures the stability of the earnings and the stock prices, while comparing the debt-to-equity ratios helps in assessing the financial leverage and risks to the business. 

• Timings and the Context: Evaluating the businesses in the same comparable climates ensures relevant comparisons. Also, taking into consideration the prevailing sentiments of the market and the perceptions of the investor helps in providing a contextual background for the analysis. 

• Qualitative Factors: As we have already mentioned, the evaluation of the skills, tracking the management team record and the experience help in making a better analysis. Also,a ssessing the reputation of the brand and the perception of the customers impacts the valuation of the company. Lastly, understanding the collaborations of the company with other businesses provides an insider edge into the positioning of the market. 

What are the Advantages of the Comparable Company Analysis? 

• Easy to Use: As we have right disucssed that this method of the valuation uses lesser list of the assumptions as compared to the other methods of valuation which makes this method an easier option to be opted out. 

• Date Widely Available: We have already stated in the above parts of this blog that this method of the Comparable Company Analysis is widely used on publicly traded companies, the data for which is available online. 
• Easier Calculations: This advantage is the added advantage of the first point as the calculations for the Comparable Company Analysis method are very easy, which makes the calculations easier for the investors to use. 

• Flexibility to Apply: Comparable Company Analysis is a method that can be flexibly applied by different analysts, industries, start-ups, or established manufacturing firms. 

• Used as a Complementary Tool: The Comparable Company Analysis method can be used as a complementary tool with other valuation methodologies such as the Discounted Cash Flow and PTA. 

What are the Disadvantages of the Comparable Company Analysis? 

• Limited Public Data: Since the method of the Comparable Company Analysis depends heavily upon the publicly available data, sometimes the valuation of a company is also affected by the private data such as the undisclosed strategies or the upcoming products of the organisation.

• Finding of the Comparables: The most important issue with this method is to find similar companies as it becomes extremely difficult to identify the comparable companies, especially in the case of unique and niche entities. With this issue, the valuation so arrived can be made redundant.  

• Market Stability: The stability of the market is also an issue as this method is totally reliable upon the current market conditions, which are susceptible to short-term market fluctuations, which makes the long-term valuation of the company less reliable. 

• Biasedness in Perception of the Market: In this method of valuation by the Comparable Company Analysis, the market efficiency is always assumed and is often reflected in the market sentiment, which does not align with the intrinsic value of the company, thereby leading to mispricing. 

• Not paying heed to the Future Prospectus: The Comparable Company Analysis method always focuses on the historical data and the future growth prospectus or the shifts in the industry are always overlooked, which also plays a crucial role in defining the valuation. 

What is the Rationale behind the Comparable Company Analysis? 

• Strategic Planning: One of the main rationales behind using this method is to strategise the next move by the companies in the market. It is extremely important to understand how companies are valued, positioned and perform. These important decisions influence some of the key strategic decisions of the company, such as diversifying the product lines, entering new markets, or altering the business models. 

• Transparent Opinions: The Comparable Company Analysis method provides for the provisions of quantitative opinions, which are independent assessments conducted in order to ascertain the fairness of the financial terms in a transaction. With this analysis, the decision-making process for the stakeholders who are involved in the process of the corporate restructuring, mergers or acquisitions becomes easier. 

• Mergers and Acquisitions: This rationale is the extension of the above rationale where this method of the Comparable Company Analysis helps in determining the offer price of the target company as it helps in determining how similar companies are being valued. This also enables the acquirers to propose a fair market value that truly reflects the correct market standing and the future potential of the target company. 

• Benchmarking: The Comparable Company Analysis method allows positioning the target company in the broader market by comparing it with the firms with similar size and similar operations. This will, in turn, help the companies to understand as to where the company is standing by taking into consideration the relevant metrics compared to the other peers. 

• Investment-related Decisions: In this process of the valuation of the Comparable Company Analysis, the market valuation and the financial health of the comparable companies are taken into consideration, which helps in better identifying the investment opportunities and the associated risks with it. 

• Meeting with the Reporting and Financial Compliances: In order to proceed with the financial reporting of the organisations the companies are required to assess the fair market value of the liabilities and their assets, especially at the time of dealing with the disposals and acquisitions. This is where the comparable company Analysis method comes into the picture as it provides a market-based approach and helps in ensuring the fulfilment of the accounting standards. 

• Buyback of Shares: For the completion of the buyback of the shares, the Comparable Company Analysis is widely used. 

• Initial Public Offerings and the Follow on Offerings: In order to raise the funds initially and even for the subsequent issue of the funds, this method of the Comparable Company Analysis plays an important role. 

Process of the Valuation of the Comparable Company Analysis 

• Analysing the Target Company: The first step in the process is to analyse the target company. With the help of an analyst, all the information related to the company is gathered, which in turn will help in the classification of the industry and a detailed description helps in the later stage of the process to choose the right peer groups. This first stage screening process includes screening on the basis of the following:
• Size
• Growth Rate
• Margins
• Industry 
• Profitability

• Identifying the Comparable Companies: The important step in the process of the Comparable Company Analysis is to find the right peer group. It is the analysts who begin this process by taking into consideration the industry classifications and the descriptions from the available business and financial databases. These often include the financial metrics, growth rate, geography, and the size of the industry, thereby ensuring a close match between the target and the company (which has been discussed in detail below).

The criteria for the selection of the Peer Group are as follows: 

• Risks: The risks associated with the industry are required to be considered as they depend upon various external factors such as the industry-specific challenges, regulatory changes, and the competitive landscape. 

• Characteristics of the Business: This is one of the main elements of selecting the peer group as it includes factors such as the service and the product mix, the customer type that is required to be aligned closely with the target company for ensuring a smooth comparison. 

• Financial Metrics: The key financial metrics, such as the operating margins and revenue growth, ensure that the companies within the peer group operate under similar performance benchmarks and economic conditions. 

• Gathering the Financial Data of the Company: After the selection of the peer groups, the next step in the process is to gather the relevant financial data. These financial data can be obtained through the Data Platforms such as Capital IQ, Bloomberg Terminal, etc. These data platforms enable the data to be imported directly into the Excel Sheets. Usually, the data required to be collected are:

• Name of the Company
• EPS
• EBITDA
• Revenue
• Share Price
• Net Debt
• Analyst Estimates
• Value of the Company

• Setting the Comparable Tables: After obtaining the data sets from the above-mentioned platforms, the information so obtained is then organised in the comparisons table in the Excel workbook by listing the names of the company, market cap, net debt, revenue, and the other financial pertinents. These data in the Excel allow us to draw a clear comparison amongst different entities. 

Below is an example of the creation of a table: 

Company	Price per Share (in Rs.)	Market Cap (Cr) (in Rs.)	TEV (Cr) (in Rs.)	Sales (Cr) (in Rs.)	EBIDTA (Cr) (in Rs.)	EBIT (Cr)(in Rs.)	Revenue (Cr) (in Rs.)	EV/Sales
ABC Ltd.	139	324	365	242	17	16.32	16.32	1.5 x
XYZ Ltd.	121	217	234	213	13	11.24	10.33	1.09x

• Calculation of the Ratios: After drawing the comparisons, the financial data is valued by using the various multiples such as the EV/Revenue, P/BV, P/NAV, EV/Gross Profit, EV/EBITDA or P/E and these ratios help in understanding the process as to how markets work and value the peer groups. 

• Valuation: Lastly, the average or the median multiples from these comparable companies are applied to the subject financials of the company to estimate its value. 

• Interpreting the Results: After the completion of the comparables table, the next step in the process is the interpretation of these results. One of the ways to use this information is to look for the companies that are either overvalued or undervalued. Therefore, in order to understand the comparables table, a good and thorough knowledge of the comparable table is required. 

What is the difference between the Comparable Company Analysis and the Precedent Transaction Analysis? 

Comparable Company Analysis and Precedent Transaction Analysis are both types of valuation methodologies that are used for determining the worth of the company by comparing them with the other similar entities. These valuation methodologies both use the multiples such as the EV/EBITDA and EV/Revenue, as these multiples differ in their implications as well as applications. 

Comparable Company Analysis focuses on the current market multiples without obtaining a takeover premium by reflecting the ongoing trading values in the open market, while, on the other hand, the Precedent Transaction Analysis includes the takeover premium and depends upon the mergers and acquisitions data, which sometimes does not include the latest market conditions. 

The choice of the correct market approach depends on the purpose of the valuation and the availability of the data. Comparable Company Analysis is useful in the case of regular valuation needs. 

What is the difference between the Enterprise Value and Equity Value Multiples? 

It is an established rule that the Enterprise Value, Equity Value Multiples and the operating metrics such as the EBITDA cannot be compared absolutely. Though comparisons are viable among the companies, the valuation can be termed as:

• Market Capitalisation = Enterprise Value – Net Debt
• Enterprise Value = Market Cap + Net Debt
• TEV/EBITDA = Enterprise Value / EBITDA
• TEV/EBIT = Enterprise Value / Operating Income
• TEV/Revenue = Revenue/ EBITDA
• P/E Ratio = Market Cap/ Net Income 

The Multiples and Finacial Modelling 

We have by far learnt the importance of these valuation models and their role in the financial modelling as these are commonly used as the terminal value assumptions in the Discounted Cash Flow Models by taking the most common assumption of the EV/EBITDA multiple which is currently based upon the observable market prices. 

Besides, these multiples are also used to bind the results of the financial model back to reality. 

Conclusion 

The method of Comparable Company Analysis is used for the purpose of the valuation of the enterprise by comparing it with similar businesses in the same industry and of the same size. This method is usually opted for Mergers and Acquisitions, IPO/FPO, Buyback of the shares, etc this is why it becomes extremely important to read the comparable tables in a thorough detail.  

Frequently Asked Questions on Comparable Company Analysis

Q 1. What is a comparative analysis of A company?

Ans 1. It is a process that is used for the valuation of the company by using the metrics of another business of the same industry and same size.

Q 2. What are the benefits of comparable company analysis?

Ans 2. The comparable company approach has numerous benefits ranging from ease of use to transparency and adaptability.

Q 3. What are the four types of comparative analysis?

Ans 3. The four types of comparative analysis are encompassing, individualising, universalising, and variation finding.

Q 4. How to calculate EV?

Ans 4. The formula for calculating EV is EV = market capitalisation + market value of debt- cash and equivalents.

Q 5. What is TEV in finance?

Ans 5. TEV stands for the total enterprise value in finance that measures the total value of the company.

Q 6. What is he difference between comparable company analysis and precedent transaction analysis?

Ans 6. Comparable company analysis uses the current multiples that can be observed in the market, while precedent transaction analysis uses the precedents, which includes a takeover premium.

Q 7. What are the 3 types of comparative?

Ans 7. The 3 types of comparative are comparative of inferiority, comparative of equality, and comparative of superiority.

Q 8. What is an EV of A company?

Ans 8. An EV stands for the enterprise value of the business valuation, which businesses often use for mergers or acquisitions.

Q 9. How to calculate NPV?

Ans 9. NPV is calculated as NPV = Cash Flow / (1+i) ^T – Initial Investment 

Q 10. How to calculate WACC?

Ans 10. WACC = ( E/V* Re) + ((D/V * Rd) * (1-T))