Comparables and precedents: valuing a company by what others are worth

01relative valuation, and why it dominates

• Two parts: a standard, and a peer group¹

  A relative valuation needs prices put on a common footing - converted into multiples of earnings, book value or sales - and a set of similar firms to compare them with. The second part is the hard one: no two firms are identical, and firms in the same business still differ on risk, growth and cash flow.

• Why it is everywhere¹

  Most equity research reports and many acquisition valuations rest on a multiple and a group of comparable firms. A relative valuation needs far fewer assumptions than a DCF, takes far less time, and is easier to present to a client.

• It measures the market's mood, not value¹

  Because a multiple is read off current prices, a relative valuation lands closer to the market price than a DCF does - and inherits the market's errors. When a whole sector is overvalued, every company in it can look fairly priced against its peers.

next: using a multiple properly →

02using a multiple properly

Enterprise value from equity

EV = equity value + debt − cashPreferred shares and minority interests are added the same way when they exist.

Implied value from a multiple

implied EV = target EBITDA × peer EV/EBITDA

Back to the share price

price per share = (implied EV − net debt) / diluted shares

• Match the numerator to the denominator¹

  An equity value goes over an equity measure - price over earnings per share - and an enterprise value over a firm-wide one such as EBITDA. Price to EBITDA mixes the two, and makes a company carrying heavy debt look cheap next to one carrying none.

• Define it the same way for every company¹

  Even the P/E has variants - current, trailing, forward, diluted, before or after extraordinary items - and in a period of rising earnings the forward figure is the lowest. Pick one definition and apply it to every firm in the group, or the comparison is between definitions rather than companies.

• Four checks before trusting one¹

  Damodaran's four steps: define the multiple consistently; look at its distribution across the sector and the whole market; understand which fundamentals drive it; then choose comparables and control for the differences that remain.

• A peer group can be chosen to reach any answer¹

  The ease of picking a multiple and a set of peers is also the method's weakness. An analyst free to choose both can justify almost any value, and the assumptions behind the choice are rarely written down.

• From peer multiples to a share price (illustrative)¹

  Five peers trade at 8x, 9x, 10x, 11x and 12x EBITDA: a median of 10x and a middle range of 9x to 11x. The target makes EBITDA of 50, has net debt of 120 and 40 million diluted shares. At the median, EV = 50 × 10 = 500, equity = 500 − 120 = 380 and the price is 380 / 40 = 9.50. Across the range EV runs 450 to 550, equity 330 to 430 and the price 8.25 to 10.75. One turn of multiple either way moves the EV by 50, or 10%, but the equity by 50 of 380, or 13%: net debt does not move with the multiple, so the equity takes all of the change.

next: precedent transactions →

03precedent transactions

Control premium

premium = offer price / unaffected price − 1

• What buyers paid for whole companies²

  Precedent transaction analysis values a company from the prices paid for comparable companies in past acquisitions, where trading comparables use today's share prices of similar listed companies.

• Why precedents usually come out highest^2,3

  An acquirer pays a control premium over the unaffected share price to persuade shareholders to sell - normally around 25 to 30%, and sometimes 50% or more. Deal multiples carry that premium, so they tend to sit above trading multiples and standalone DCF values.

• The premium, applied (illustrative)³

  Carry on from the comps example: a share worth 9.50 on trading multiples, offered for at a 30% premium, is bid at 9.50 × 1.3 = 12.35. Equity value goes from 380 to 494 and, with net debt unchanged at 120, the EV from 500 to 614 - about 12.3x EBITDA of 50, which is how a deal multiple comes to sit above the 10x the peers trade on.

• Strategic buyers pay more³

  Revenue and cost synergies, competitive bidding and the strategic value of the asset all push the premium up. Strategic buyers typically pay more than financial buyers because they can capture synergies a fund cannot.

• Few, recent and truly comparable²

  Deals should be recent enough to share today's market conditions, and a handful of genuinely comparable transactions says more than a long list. Disclosure is the practical limit: the parties to a deal have no obligation to publish its details.

• A range, not a point²

  The output is a range: median or mean multiples applied to several metrics - EV/revenue, EV/EBITDA, P/E - each give a value, and the analysis reports where they fall.

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