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 –  

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.
Comparable Company Analysis

What is Comparable Company Analysis?


(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.

Aparment Analogy

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.

investopedia definition

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?


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 –

Box IPO Comparable Analysis Comp

 

  1. Company Information
  2. Size of the 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
  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


Let us now look at the summary of Comparable Company analysis of Box IPO.

Box Valuation using SaaS Comparables

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 ipo 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


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
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 –

comparable company analysis - summary

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:

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

Comparable Comp - Step 1

Step 2: Input the latest available Balance Sheet information

Comparable Comp - Step 2

Step 3: Calculate all the “in the money” stock options

Comparable Comp - Step 3

Also, look at the Treasury Stock MethodTreasury Stock MethodTreasury Stock Method is an accounting approach assuming that the options & stock warrants are exercised at the beginning of the year (or date of issue, if later) & proceeds from the exercise of these options & warrants are used to repurchase shares in the market. read more and Restricted Stock UnitsRestricted Stock UnitsRestricted Stock Units or RSU can be defined as stock-based compensation that is issued as company’s stock to an employee. The company establishes vesting requirements based on the performance of an individual and the length of the employment.read more.

Step 4: Calculate all the “in the money” convertible securities

Comparable Comp - Step 4

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 the detailed post on non-recurring itemsNon-recurring ItemsNon-recurring items are income statement entries that are unusual and unexpected during regular business operations; examples include profits or losses from sale of asset, impairment costs, restructuring costs, and losses in lawsuits, and inventory write-off.read more)

Comparable Comp - Step 5

Step 6: Calculate the Equity Value and Enterprise Value

Comparable Comp - Step 6

 Step 7: Calculate the respective multiples

Comparable Comp - Step 7

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 liquidityLiquidityLiquidity shows the ease of converting the assets or the securities of the company into the cash. Liquidity is the ability of the firm to pay off the current liabilities with the current assets it possesses.read more 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 Shares are 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 InterestMinority InterestMinority interest is the investors' stakeholding that is less than 50% of the existing shares or the voting rights in the company. The minority shareholders do not have control over the company through their voting rights, thereby having a meagre role in the corporate decision-making.read more 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.

You can also look at SOTP Valuation and DCF or Discounted Cash FlowDCF Or Discounted Cash FlowDiscounted cash flow analysis is a method of analyzing the present value of a company, investment, or cash flow by adjusting future cash flows to the time value of money. This analysis assesses the present fair value of assets, projects, or companies by taking into account many factors such as inflation, risk, and cost of capital, as well as analyzing the company's future performance.read more approach to enhance your knowledge in valuations.

What’s Next?

If you learned something new from this post, please leave a comment below. Let me know what you think. Thanks and take care. 

Comparable Company Analysis Video

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Comments

  1. Ravinder says

    Thanks for the great info

    • Dheeraj Vaidya says

      Thanks for your kind words!

  2. Gopal Naidu says

    Your presentation of the concepts is very good. Thank You sir,

    • Dheeraj Vaidya says

      Thanks for your kind words!

  3. TS says

    Hi there,

    Great article, especially liked the section #4 on professional comparable company analysis. The article covers comprehensively what are involved in the comparable companies analysis.

    I happen to notice something on section #2 and I would like to clarify. Its the section where 3 cases of price per share is determine from EV/ Revenue implied.

    Enterprise Value = Market Cap + Debt – Cash,
    therefore, Equity value (M. Cap) = EV – Debt + Cash

    thus, the equity value should be:
    Pessimistic – 1,487,393
    Base – 2,008,043
    Optimistic – 2,729,313

    Could you clarify if this is correct? Coz I am trying to grasp the full concept of EV and Equity calculation, and this one just confuses me a little.

    Thanks!

    • Dheeraj says

      Hello TS,

      Many Thanks for your note and pointing out the errors in excel calculation of Box valuation scenarios. Your logic of EV and Equity is correct.

      Thanks once again.

      Best,
      Dheeraj

  4. Vivek Pandey says

    Hi Dheeraj,

    Again a big thanks to you for clarification of doubts like; why we deduct cash from EV and other things. Excellent really very helpful.

    • Dheeraj says

      thanks Vivek. I am glad you liked the post!

  5. Dhruv says

    Thanks for such an informative post.

    • Dheeraj says

      thanks for your kind words Dhruv.

  6. sonal says

    hello…
    what exactly is LTM numbers & in-the-money

  7. ankit soti says

    hey sir! we just love the way u explain all these things. They help us a lot!

  8. jennifer says

    Thanks for this wonderful post. I have one suggestion. You should write frequently as post like these help us a lot.

  9. megha says

    i would like to thank you so much.. a good study material with very clear level to make understand step by step full tutorial,would like to know transaction and dcf analysis ,, as i am finding difficulty in dcf analysis..please help me further,,i hope u will guide me step by step for further analysis

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