Why use Comparable Trading Multiples (Comps)?
Analyzing comparable trading multiples (Comps) involves analyzing companies with similar operating, financial, and ownership profiles to provide a useful understanding of:
- Operating and financial statistics about an industry group (growth rates, margin trends, capital spending requirements, etc.). It is especially helpful in making assumptions for a discounted cash flow analysis.
- The relative valuation of publicly listed companies. Comps are especially useful in that they can be used to assess if a publicly traded company is over or undervalued relative to peers.
- Valuation multiples from comparable companies may be applied to the financials of the target entity, giving a theoretical value of the target business.
- An indicative market price for a company that is to be floated on the stock market.
- The validity of terminal DCF assumptions.
- Benchmarks for IPO valuations.
Note: This is an excerpt from CFI’s free investment banking book.
Comparable Trading Multiples Universe
When conducting comps analysis, companies (both target and comparable) should have similar:
- Business activities – industry, products, and distribution channels
- Geographical location
- Size
- Growth profiles (including seasonality and cyclicality)
- M&A profiles
- Profitability profiles
- Accounting policies
- Market liquidity of securities
- Breadth of research coverage
*Capital structures when conducting equity level comparables
Essentially, be selective and specific when choosing comparable companies. More comparables are not always better!
Sources of Information for Comparable Trading Mutiples
| Information | Source |
|---|---|
| List of comparable companies | Sector brokers’ reports Bloomberg Hoovers Prospectuses (often have a “Competition” section) |
| Share price | Datastream or Bloomberg |
| Shares outstanding | Most recent annual report (or interim results or 10Q) updated for any subsequent changes – for UK companies see Regulatory News Service (RNS) for changes Bloomberg |
| Options outstanding and exercise price of options | Most recent annual report (or, unusually, interim results or 10Q) updated for any subsequent changes reported Companies reporting under US GAAP will disclose the weighted average exercise price |
| Debt and cash | Most recent annual report or more recent interim results or 10Q |
| Preference shares | Most recent annual report or more recent interim results or 10Q |
| Minority interests | Most recent annual report or more recent interim results or 10Q |
| Income statement information | Most recent annual report (or more recent interim results or 10Q if last 12 months [LTM] analysis is to be done) |
| Forecast financials | Broker research I/B/E/S database (the median of all estimates) |
| General information | Extel cards and Datastream 101A |
From Equity Value to Enterprise Value
Enterprise value = Equity Value + Net Debt + Minority Interest
- Enterprise value (EV) is a measure of a firm’s total value. Interchangeable terms for EV include entity value (EV), gross value (GV), total capitalization, firm value (FV), and others.
- Equity value is the value of a company that is available to shareholders, synonymous with Market capitalization (MC).
- Net debt = Borrowings – Cash + Liquid resources
- Net debt simply refers to the total debt of a company minus cash on hand.
- Preference share capital may be considered net debt due to its debt-like characteristics.
When to Use Equity Value vs. Enterprise Value
As you can see in the image below, the different trading multiples are organized into groups based on the numerator in the multiples. If the numerator is above the interest line on the income statement its an enterprise value multiple (like EV/EBITDA). If the numerator is below interest expense, then it becomes an equity value multiple, like P/E ratio.
Impact of capital structures on comparable trading multiples
Which multiple to use
Different financial ratios serve different functions in comparable trading multiples analysis. Before using any multiple, the following questions need to be answered:
- What is the development stage of the target company relative to comps?
- What is the appropriate comps universe trading on?
The following table outlines the key pros and cons between comps:
| Pros | Cons | |
|---|---|---|
| EV/Sales | • Suitable for companies with similar business model / development stage | • Does not take into account varying revenue growth rates |
| • May be the only performance related multiple available for companies with negative EBITDA | • Does not address the quality of revenues | |
| • Sectors where operating margins are broadly similar between companies | • Does not address profitability issues | |
| • Sectors where market share is important | • Inconsistency of treatment within sales of joint venture in different reporting environments | |
| • Limited exposure to accounting differences | • Different revenue recognition rules between companies | |
| EV/EBITDA | • Incorporates profitability | • Ignores depreciation / capex |
| • Most businesses are EBITDA positive so widening the universe | • Ignores tax regimes and tax profiles | |
| • Ignores the most significant accounting differences arising from goodwill | • Does not take into account varying EBITDA growth rates | |
| • Relatively limited exposure to accounting differences | • Inconsistency of treatment within EBITDA of joint venture and other unconsolidated affiliates within different reporting environments | |
| • Other accounting differences such as revenue recognition, capitalization policies, finance vs. operating leases | ||
| EV/EBIT | • Incorporates profitability | • Depreciation / amortization policies may differ |
| • Useful for capital intensive businesses where depreciation is a true economic cost | • Ignores tax regimes and tax profiles | |
| • Good for companies within the same reporting environment where accounting differences are minimized | • Does not take into account varying EBIT growth rates | |
| • Inconsistency of treatment within EBIT of joint venture and other unconsolidated affiliates within different reporting environments | ||
| • Other accounting differences such as revenue recognition, capitalization policies, finance vs. operating leases | ||
| P/E | • Widely used in traditional industries with high visibility of earnings | • Depends on corporate structure |
| • Widely understood | • Accounting policies results in a significant impact on earnings | |
| • Quick and easy calculation | ||
| • Useful to check DCF exit assumptions |
Using comparable trading multiples
The following is a comprehensive example from the Investment Banking Manual, which demonstrates the use of comps:
Company X is to be valued using Company Y as a comparable company.
Valuing target – Company X
How to use comps
Additional resources
Thank you for reading this section of CFI’s free investment banking book on Comparable Trading Multiples (Comps) . To keep learning and advancing your career, the following resources will be helpful:
