Valuation Techniques: Comparable Company Analysis (Comps)

• VALUATION TECHNIQUES

Valuation is a process of determining the present or future worth of any asset or company. The valuation technique, in turn, is the process of finding the intrinsic value of an asset, be it a company, a project, or even a financial instrument. So, to find this value, there are various methods used. DCF analysis, comparative company analysis, precedent transactions, Market capitalization, Times revenue method. Valuation methods provide a structure to assess the worth of and compare the financial data, enabling companies to make informed decisions regarding investment opportunities, business growth strategies, or potential mergers and acquisitions. 

• COMPARABLE COMPANY ANALYSIS (COMPS)

A comparable company analysis (CCA), also known as “comps analysis,” is a basic tool of valuation method that is used in investment banking. This approach involves comparing the financial data and valuation ratio of a target company to those of a similarly publicly traded company. 

This concept of this valuation is that businesses in the same field, having similar financial and operational traits, should have similar valuations. This approach is commonly favored because it’s closely tied to market conditions. 

Comparable company analysis begins by identifying a group of similar companies, all of similar size, within the same industry or region. This allows investors to compare a specific company to its competitors. The data gathered can help determine the company’s enterprise value (EV) and other metrics used to compare it with its peers. 

STEPS INVOLVED IN COMPARABLE COMPANY ANALYSIS:

• Select the right peer group. This is the first and most difficult step, which is to perform the ratio analysis of the public company if they are not available publicly. These companies should operate in the same industry, have similar size, growth rates, margins, and geographic exposure. The closer the match with the target company, the better. The criteria include geographic, size—that is, its revenue, assets, employees, what is its growth rate, its margin, and profitability.
• Gather financial information. Once the list of companies is collected that are more relevant to the company one is trying to value, the next step is to gather its financial information. The information that needs to be gathered is EBITDA (earnings before interest, tax, depreciation, amortization), net income, and earning per share (EPS), but for companies in an earlier stage, one should look at their gross profit or revenue. The data collected should be recent and not older than 12 months. If there is no access to the expensive tools like Bloomberg and Capital IQ, then one can manually gather this information from the annual or quarterly reports, but the only fact is that it will be time-consuming.
• Calculate valuation multiples and setup the comps table. The next step is to find common valuation multiples and put them in the comps table, which is an Excel spreadsheet. This will contain relevant information about all the companies that one is going to analyze. The main comparable company analysis will include the company name, share price, market capitalization, enterprise value, revenue, EBITDA, and the analyst estimates.
• Calculate the comparable ratios. After the comps table has been populated, the next step is to calculate ratios so that the comparison will be easy. The main ratios that need to be included in the table are: price earning (P/E), enterprise value to revenue multiple (EV/Revenue), price to book value (P/B), price to net asset value (P/NAV), and any other ratios that a company feels are important and need to be considered. 
• Apply the multiples to the target company. Now use the calculated multiples for the group of companies to estimate what the value of the target company is. Analysts will usually take the average or median of the comparable companies multiple times, and then they will apply them to the gross profit, revenue, EBITDA, net income, or whatever other metrics they have included in their comps table. 

In order to come up with a meaningful average and comparable state, they often remove or exclude the outliners and continue to massage the numbers until it seems relevant and realistic. 

• Arriving at the valuation range and formatting the table: After using various multiples, the company must arrive at the valuation range of the target company, which is typically one should know its low, median, and high valuation.

When all this is done, a good financial analyst would see the comps table and do formatting if needed because it’s important to clearly separate financial data, market data, and their multiples into different sections so that it will be easy for the reader to look into the information and it will also make decision-making easy.

• Interpreting the results: Once all the figures and the comps table are finalized, it’s time to start interpreting what the results are. The first thing is to see whether the company is overvalued or undervalued; it will help to look into the opportunities that are present in the market.

In investment banking, Comparable Company Analysis (Comps) serves several key purposes:

1. Valuation for Mergers and Acquisitions (M&A):

Comps are used to value a target company. In M&A, the investment bank plays an important role, as in this transaction it compares it to a similar company and then uses the valuation multiples derived from comparable companies to determine an appropriate purchase price for the target company.

For example, when advising on a buy-side or sell-side M&A deal, investment bankers will use Comps to assess whether the deal price is fair.

2. Initial Public Offerings (IPOs):

In IPOs, Comps help determine the price range for the company’s shares, which is very important. And this price is decided by comparing with the target company and the valuation that it has reached. Investment bankers can estimate a reasonable market value for the company’s shares when it goes public.

The valuation of the company, which is based on comps, helps decide how much capital to raise and at what price it should offer its shares in the market.

3. Equity Research and Stock Recommendations:

Analysts in investment banks use Comps to evaluate whether a company’s stock is undervalued or overvalued relative to its similar company. By comparing key metrics (such as P/E ratios or EV/EBITDA multiples), analysts can issue recommendations to clients.

4. Debt and equity financing:

When companies want to raise capital through debt or equity issuance, comps help investment bankers gauge the company’s value and its market position. to  This influences the terms of the financing deal, including the pricing and structure of the securities.

5. Benchmarking:

Investment bankers compare the financial metrics like growth rates, margins, and return on capital to determine whether the target company is performing in line with the industry standards. So, Comps helps in benchmarking.

CONCLUSION:

Comparable Company Analysis is a crucial tool for determining the market-based value of the firm, and investment banks play an important role as their analysts do this analysis for the company because it cannot be done without the help of experts.