Comparable Company Analysis

Comparable Company Analysis

This is Part 2 of the equity valuation series articles. Comparable comps are 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 the fair valuation of the industry and the company.

In this article, we discuss the following –  

• What is Comparable Company Analysis?
• How to read a 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 a reasonable knowledge of Relative Valuation Multiples like EV/EBITDAEV/EBITDAEV to EBITDA is the ratio between enterprise value and earnings before interest, taxes, depreciation, and amortization that helps the investor in the valuation of the company at a very subtle level by allowing the investor to compare a specific company to the peer company in the industry as a whole, or other comparative industries.read more, PE RatioPE RatioThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. read more, Price to Book valuePrice To Book ValuePrice to Book Value Ratio or P/B Ratio helps to identify stock opportunities in Financial companies, especially banks, and is used with other valuation tools like PE Ratio, PCF, EV/EBITDA. Price to Book Value Ratio = Price Per Share / Book Value Per Share read more, PEG RatioPEG RatioThe PEG ratio compares the P/E ratio of a company to its expected rate of growth. A PEG ratio of 1.0 or lower, on average, indicates that a stock is undervalued. A PEG ratio greater than 1.0 indicates that a stock is overvalued.read more, 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.

What is Comparable Company Analysis?

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(also called as “Trading Comps”, “Comparable Comps”)

Comparable analysis or Trading comps can be best explained with the 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 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.

https://www.trulia.com/NY/New_York/

When you are comparing apartments, you would consider different attributes such as the number of rooms, size of bedrooms, number of bathrooms, layout, etc. In doing so, what you would notice is that apartments with similar kinds 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.

source -WSM

From the above apartment related discussion and Investopedia definition, we can draw the following inferences regarding comparable analysis –

1. 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
2. Instead of looking at the number of beds, location, bathrooms, etc., you look at relative valuation multiples (like EV/EBITDA, PE, P/BV, etc.).
3. You infer from such a comparison regarding a company’s price is overvalued or undervalued.

 I guess with this basic analogy; we should be able to proceed and move forward to reading the comparable company analysis.

How to read a Comparable company analysis table?

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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 IPOBox IPOThe analysis of the Box IPO valuation can be done using various methodologies which are Relative Valuation – SaaS Comparable Comps, Comparable Acquisition Analysis, Using Stock-Based Rewards, Valuation cues from Private Equity Funding, Valuation cues from Dropbox Private Equity Funding, and Discounted Cash Flow Approach for Box IPO Valuation.read more. There are broadly 5 parts to the trading comps table –

 

1. Company Information –
   • This includes Company Name, Ticker, and Price. The ticker is a unique symbol given to the company to identify publicly listed companies.
   • You may take Bloomberg, Reuter’s tickers as well. Also, note that the 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.
2. Size of the company –
   • This includes Market Capitalization and 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.
3. 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 forwarding multiples (estimated)
   • Choosing an appropriate valuation tool is the key to successfully valuing the company.
4. 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 MarginsProfit MarginsProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read more, ROE, Net Margin, Leverage, etc. to make this comp more meaningful.
5. 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
   • overvalued
   • 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

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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%).
• THE lowest EV/Sales multiple is 2.0x
• Cloud companies trade at EV/EBITDA multiple of 32x.

Box Valuation

• 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 the 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.

The 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)
• The most expected valuation for Box Inc using Relative Valuation is $21.40 (expected) 

How to Identify Comparable Companies

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The most important element of Comparable analysis is to identify the right set of comparable. Comparing the 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 and cannot be relied on completely.
• If there is no surety about the industry classification (which is the case most of the time), try to identify some keywords relevant to the business descriptions of the companies. E.g. For a 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 scenarios, one needs 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 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 template 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 the conversion of bonds will not take place.

Comparables Company valuation Steps:

• Input basic information
• Input Balance Sheet information
• Calculate “in the money” stock optionsStock OptionsStock options are derivative instruments that give the holder the right to buy or sell any stock at a predetermined price regardless of the prevailing market prices. It typically consists of four components: the strike price, the expiry date, the lot size, and the share premium.read more
• 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.