Comparable Company Analysis – This is Part 2 of the equity valuation series articles. Comparable comps is nothing but identifying doing relative valuations like an expert to find the fair value of the firm. The comparable comp process starts with identifying the comparable companies, then selecting the right valuation tools and finally preparing a table that can provide easy inferences about fair valuation of the industry and the company.
In this article, we discuss the following –
- What is Comparable Company Analysis?
- How to read comparable company analysis table?
- Box IPO Comparable Comp Analysis
- How to identify comparable companies?
- How do we prepare a professional comparable company analysis table
- Important adjustments in Comparable Company Analysis
In order to fully understand these concepts, you should have reasonable knowledge of Relative Valuation Multiples like EV/EBITDA, PE Ratio, Price to Book value etc. However, If you want a quick refresher, you may refer to Part 1 of this equity valuation series that covered the topic of Relative Valuation multiples
If you want to learn Equity Research professionally, then you may want to look at 40+ video hours of Equity Research Course
What is Comparable Company Analysis?
(also called as “Trading Comps”, “Comparable Comps”)
Comparable analysis or Trading comps can be best explained with a help of an example – let’s assume that you are planning to buy a house in New York (why not?). Obviously you may search on the many of real estate brokerage websites and would also draw a comparative study on the same. You would compare one apartment with another and would also try to get a sense of what they are worth as compared to each other.
When you are comparing apartments, you would consider different attributes such as number of rooms, size of bedrooms, number of bathroom, layout etc. In doing so, what you would notice is that apartments with similar kind of attributes may cost similarly!
In this context, let us now try and understand what is comparable “Company” analysis? or Comparable comps. Below is the definition sourced from Investopedia.
From the above apartment related discussion and investopedia definition, we can draw the following inferences regarding comparable analysis –
- Just like comparing the apartments, comparable company analysis helps you compare different companies with similar size and industry and derive a fair value for them
- Instead of looking at the number of beds, location, bathrooms etc, you look at relative valuation multiples (like EV/EBITDA, PE, P/BV etc).
- You infer from such comparison regarding a company’s price is over valued or under valued.
I guess with this basic analogy we should be able to proceed and move forward to reading the comparable company analysis.
How to read comparable company analysis table?
For learning to read a comparable company analysis table or Comparable Comps, I will take a real life example, Box Inc that had earlier announced its IPO. We want to understand at what valuation price point should we invest in Box Inc IPO shares.
Below is the comparable company analysis table for Box IPO. There are broadly 5 parts to the trading comps table –
- Company Information –
- This includes Company Name, Ticker and Price. Ticker is a unique symbol given to the company to identify publicly listed company.
- You may take bloomberg, reuters tickers as well. Also, note that prices that we take here are the most recent prices.
- We make the table in such a way that these prices are linked to the database where they would get updated automatically.
- Size of the company –
- This includes Market Capitalization and market Enterprise Value.
- We normally sort the table on the basis of Market Capitalization. Market Capitalization also provides us pseudo for the size of the company.
- Enterprise Value is the current Market based valuation of the firm.
- We may not want to compare a small market capitalization company with a large capitalization company.
- Valuation Multiples –
- This should include 2 to 3 appropriate valuation tools for comparison
- We should ideally show one year of historical multiple and two years of forward multiples (estimated)
- Choosing an appropriate valuation tool is the key to successfully valuing the company.
- Operating Metrics –
- This may include fundamental ratios like Revenue, growth, ROE, etc
- This is important so that we can understand the fundamentals of the company at once.
- You may include Profit Margins, ROE, Net Margin, Leverage etc to make this comp more meaningful.
- Summary –
- This is a simple mean, median, low and high of the above metrics
- Mean and Median provides core insights to the fair valuation
- If a company’s multiple is above the mean/median, we tend to infer that the company may be
- Likewise, if the multiple is below the mean/median, we may infer undervalued.
- High and Low also helps us in understanding the outliers and a case to remove those if they are too far away from the Mean/Median.
Reading the Trading Comp / Comparable Company Analysis – Box IPO
Let us now look at the summary of Comparable Company analysis of Box IPO.
We can infer the following from the above table –
- Cloud companies are trading at an average of 9.5x EV/Sales Multiple.
- We note companies like Xero is an outlier that trades at 44x EV/Sales multiple (expected 2014 growth rate of 94%).
- Lowest EV/Sales multiple is 2.0x
- Cloud companies trade at EV/EBITDA multiple of 32x.
- From the financial model of Box, we note that Box is EBITDA Negative so we can’t proceed with EV/EBITDA as a valuation tool. The only multiple that is suitable for valuation is EV/Sales.
- Since the median EV/Sales is around 7.7x and mean is around 9.5x, we may consider making 3 scenarios for valuations.
- Optimistic case of 10.0x EV/Sales, Base Case of 7.1x EV/Sales and Pessimistic Case of 5.0x EV/Sales.
Below table shows the per share price using the 3 scenarios.
- Box Inc valuation range from $15.65 (pessimistic case) to $29.38 (optimistic case)
- Most expected valuation for Box Inc using Relative Valuation is $21.40 (expected)
How to Identify Comparable Companies
The most important element of comparable analysis is to identify the right set of comparable. Comparing value of apple to oranges does not make any sense here. It is important to conduct a preliminary study on comparable companies and it generally involves these 3 steps –
a) Identifying the industry
- Try to zero down the industries in which the companies are classified.
- This can be tedious as different sources would give different industries for the same company and also the industry names would be different in various sources.
- Generally the classifications available are very broad ones and cannot be relied completely
- If there is no surety about the industry classification (which is the case most of the times), try to identify some keywords relevant to the business descriptions of the companies. E.g. For Building materials company, the relevant keywords can be – roofing, plumbing, framing, insulation, tiling, construction service, etc.
- Though this example is simple, however, for applying the same in real life scenario, one need to establish the value and the value driver and make several adjustments to it.
b) Understand the Company description
- It is important to understand the business in order to select comparable companies.
- Try to find out the exact business description of the company.
- Possible sources for this in the order of preference would be:
- Company Website
- Research reports
- Company Filings (Latest 10K, Annual Report, etc.)
- Yahoo Finance
- Note: Company websites are very useful in helping to visualize the all the products and services, but research reports and company filings provide actual segment data to give a true business mix of the company
c) Identify key competitors
- Comparable companies can be identified from the following sources in the order of preference:
- Research Reports
- Company Filings – Competition Section
- Yahoo Finance – Competitors and Industry sections
- Hoovers – Competitors and Industry sections
Professional Comparable Company Analysis: a Step-by-Step approach
The key to preparing the comparable company analysis or Trading comp is the arrive at the right multiple (EV/Sales, P/E etc). Below is a sample summary Comparable comp analysis excel sheet –
The requisite output of Company 1, Company 2, Company 3 … is linked from the input tabs “company 1”, “company 2”, “company 3” respectively. Preparing the comparable comp table is not difficult, however, correctly calculating the requisite valuation multiple sometimes is challenging. Hence, we will focus primarily on correctly calculating these multiples with an in-depth example.
You can download the comparable comp excel tempalte from here – Comparable Company Template
Key Formulas used:
- Basic Equity Value = Common Shares Outstanding * Share Price
- Diluted Equity Value = Diluted Shares Outstanding * Share Price
- Dilution from Options = Options – ( Options * Exercise Price) / Share Price
- Dilution from Convertibles = Convertible Bonds * Conversion Ratio
- Enterprise Value = Equity Value – Cash + Debt + Minority Interest + Preferred Stock
- For the dilution calculations above, the exercise price or conversion price needs to be below the share price.
If the conversion price or the exercise price is above the Share Price, then there will be no dilution and options will not get exercised and conversion of bonds will not take place.
Comparables Company valuation Steps:
- Input basic information
- Input Balance Sheet information
- Calculate “in the money” stock options
- Calculate “in the money” convertible securities and find the diluted EPS
- Calculate the LTM numbers (ex non-recurring items)
- Calculate the Equity Value and Enterprise Value
- Calculate the respective multiples
Let us now proceed step-by-step to understand this fully. I have taken an example of Robert Half International (Ticker – RHI) and even though the data used here is pretty old (2006 10K and 10Q), i am sure it will still prove to be useful for understanding the general methodology.
Step 1: Input the basic information for a comparable company
Step 2: Input the latest available Balance Sheet information
Step 3: Calculate all the “in the money” stock options
Step 4: Calculate all the “in the money” convertible securities
As with options, you only get dilution from convertible bonds if the company’s current share price exceeds the conversion price of the bonds.
How You Factor Convertible Bonds Into Enterprise Value: If the convertible bonds are in‐the‐money (they can convert to shares) then you calculate the dilution and add them to shares outstanding. If they’re out‐of-the‐money (they cannot convert into shares) then you count the bonds as debt instead.
- Dilution from Convertibles = Convertible Bonds * Conversion Ratio
- Convertible Bonds = Convertible Dollar Amount / Par Value
- Conversion Ratio = Par Value / Conversion Price
- Conversion Price = Par Value / Conversion Ratio
Step 5: Calculate the LTM numbers (ex non-recurring items)
(If you are wondering what are non recurring items, then do have a look at detailed post on non recurring items)
Step 6: Calculate the Equity Value and Enterprise Value
Step 7: Calculate the respective multiples
Important adjustments in Comparable Company Analysis
|Items||Things to Note||Add / Subtract||Additional Info|
|Cash||Think of Cash as a “free gift” when you buy a company – it reduces your effective price because you get the target’s entire Balance Sheet as part of the acquisition.||Subtract||You almost always include Short‐Term Investments as part of the Cash number, but Long‐Term Investments depend on the liquidity and what your bank usually does.|
|Debt||Debt refers to loans that a company has taken out. Normally when you buy a company, you’re required to refinance its debt, so it’s counted as one of those “hidden costs” to make an acquisition.||Add||All debt‐related items should be counted in this number – short‐term debt, long‐term debt, revolvers, mezzanine, and so on. The only exception: convertible bonds, which may or may not be counted.It’s better to use market values for debt, but if you don’t have them you can just use what’s listed on the Balance Sheet (book values).|
|Preferred Stock||Preferred Stock is very similar to Debt – investors receive a guaranteed dividend, usually in the form of an interest rate on the Preferred Stock balance.||Add||Preferred Stock is listed on the Liabilities & Shareholders’ Equity side of the Balance Sheet.|
|Minority Interest||When you own more than 50% of another company, Minority Interest refers to the percent that you DON’T own. You need to add it back to Enterprise Value because the other company’s revenue and profit are included in your own financial statements; so you need to make sure its value is reflected in EV.||Add||Minority Interest is listed on the Balance Sheet, under Liabilities or Shareholders’ Equity – in most cases you’re fine listing what’s in the filing, but if you have market numbers you can use them.|
If you learned something new from this post, please leave a comment below. Let me know what you think. Thanks and take care.