Comparable Company Analysis

Street Of Walls of Investment Banking Technical Training

In this chapter we will cover five key topics:

Overview
Peer Universe
Market Capitalization & Enterprise Value
Historical & Projected Financials
Spread Multiples

Comparable Company Analyses (Comps) Overview

What are Comps?
Comparably Company Analyses, or Comps, are a relative valuation technique used to value a
company by comparing that companys valuation multiples to those of its peers. Typically, the multiples
are a ratio of some of some valuation metric (such as equity Market Capitalization or Enterprise Value)
to some financial performance metric (such as Earnings/Earnings Per Share (EPS), Sales, or
EBITDA). (An astute reader will note that Sales and EBITDA are enterprise-wide metrics, and this
should be used with Enterprise Value, while Earnings/EPS is an equity-related metric, and thus should
be used with Market Capitalization.) The basic idea is that companies with similar characteristics
should trade at similar multiples, all other things being equal.
Why use Comps?
Comps are relatively easy to perform, and the data for them is usually relatively widely available
(provided that the comparable companies are publicly traded). Additionally, assuming that the market
is efficiently pricing the securities of other companies, Comps should provide a reasonable valuation
range, while other valuation methods such as DCF are dependent upon an entire array of
assumptions.
These factors make Comps one of the most widely used valuation techniques in practice. Investment
bankers, sell-side research analysts, private equity investors, and other market analysts all use
Comps. They do have their disadvantages, however.
Comps Advantages and Disadvantages

PROs and CONs of Using Comps

PROs
CONs
Easy to calculate using widely available
Influenced by temporary market
data
conditions or non-fundamental factors
Easy to communicate across a variety
Not useful when there are few or non
of market participants
comparable companies
Determine a benchmark value for
Can be difficult to find appropriate
multiples used in valuation
companies for various reasons
Provide a useful way to assess market
Less reliable when comparable
assumptions of fundamental
companies are thinly traded
characteristics baked into valuations

Performing a Comparable Companies Analysis

Remember C.V.S
When doing a Comps analysis, a useful checklist of things to do has mnemonic that is easy to
remember: C.V.S.

Confirm relevant peer universe

Validate key fundamentals metrics
Select appropriate multiple for valuation

The appropriate selection of a relevant peer universe is critical for a Comps analysis, because it plays
a significant role in the valuation of the target company. For example, a company could sometimes be
compared across two different industries due to the nature of the business (an internet retail
company). Similarly, some comparable companies might need to be ruled out or adjusted because it
owns businesses across several different industry groups. Peer universe selection is therefore
somewhat subjective.
When doing a Coms valuation, the analyst can choose to either trailing (historical) performance
metrics, or future (forecast) performance metrics. (Note that many analyses will look at both historical
and future metrics.) In general future metrics are preferred, but one needs to be careful with this. For
example, projected EBITDA and projected Earnings/EPS are subject to all kinds of potential pitfalls
associated with forecasting. The forecast numbers may end up being significantly off.
Additionally, when performing a Comps analysis you may want to adjust the performance for various
one-time charges and non-recurring items (such as a sale of assets, a one-time legal expense, or a
restructuring charge.) It is important that all companies in the analysis use clean numbers to provide
an apples-to-apples comparison. This becomes especially difficult when using future performance
metrics, as the non-recurring items may be as-yet unknown.
Key Assumptions & Projections:
To quickly recap on key assumptions and projections that we need to make when performing a Comps
analysis:

Peer Universe: A selection of competitor/similar companies used to determine a benchmark

valuation.
EBITDA: Historical & projected Earnings before Interest, Taxes, Depreciation & Amortization.
EPS: Historical & projected Earnings Per Share.

Types of Multiples
There are various types of multiples that can be used in a Coms analysis. In general, multiples can be
classified in two broad categories: Operating multiples and Equity multiples. Operating multiples
refer to the operating results of the business as a whole while Equity multiples refer to the value
created from the company that is available to equity/shareholders.
Typical multiples for Comps include:

EV/Sales: The Enterprise value of the company divided by Sales/Revenue (Operating

multiple)
EV/EBITDA: The Enterprise value of the company divided by EBITDA (Operating multiple)
P/E: Price/Earnings ratio for a company (Equity Multiple). This is either calculated as Share
Price/EPS, or Market Capitalization/Earnings (they are mathematically equivalent).
P/B: Price/Book ratio for a company (Equity multiple). This is either calculated as Share
Price/Book Value per share, or Market Capitalization/Shareholders Equity (they are
mathematically equivalent).
P/(Levered) Cash Flow: Price/Cash Flow ratio for a company (Equity multiple). This is either
calculated as Share Price/Levered Cash Flow per Share, or Market Capitalization/Levered
Cash Flow (they are mathematically equivalent).

Note that for Operating Multiples we use Enterprise Value as the numerator of the calculation, while for
Equity Multiples, we use Market Capitalization as the numerator. You should generally not use EV for

equity-related performance metrics, nor should you use Market Capitalization for enterprise-related
performance metrics.
RECAP ON OPERATING MULTIPLES:

The most commonly used Operating multiples are EV/Sales and EV/EBITDA
Operating multiples ignore financial leverage (Debt) and typically ignore Depreciation &
Amortization
They value the totally company versus common stock (Equity) only.
Investment bankers and private equity investors frequently use them.

RECAP ON EQUITY MULTIPLES:

The most commonly used Equity multiples are P/E, P/B, and P/Cash Flow (Levered).
Equity multiples ignore cash flow to Debt holders.
Investment bankers and equity analysts frequently use them.

In this training course, the two most common multiples, EV/EBITDA (Operating Multiple) and P/E
(Equity Multiple), will be used. However, it is still worthwhile to be aware of other kinds of multiples, as
they are frequently used.
WHEN ARE PRICE/SALES MULTIPLES USED?
Price/Sales multiples are typically used for companies with negative, highly volatile, or abnormally
high/low EPS. For example, fast-growing companies that have no earnings yet or negative earnings
(because they are spending a lot of money to grow or have not yet reached critical mass for sales)
may be valued based upon multiples of Sales. A common advantage of using Price/Sales is the
general stability and lower accounting distortion afforded by sales numbers. However, sales numbers
can be manipulated through revenue recognition practices and growth companies can be given high
valuations given regardless of having no earnings or cash flow. Additionally, using Sales as a basis for
valuation does not take into account the profitability of those Sales figures. Some companies, for
example, may be able to turn a large profit margin on incremental sales, while others might have very
narrow profit margins.
WHEN ARE PRICE/BOOK MULTIPLES USED?
Price/Book multiples are often used to value financial services companies since their balance sheets
are primarily composed of liquid assets that often approximate market values. These multiples can
also be used for companies with no earnings, highly variable earnings or companies not expected to
continue as a going concern. Unfortunately, for most companies in most industries the Price/Book ratio
is highly idiosyncratic, because the Book Value is a function of all past business activities (literally
since the companys founding or most recent recapitalization). Therefore Price/Book ratios can swing
wildly depending on each companys circumstances.
WHAT ARE CASH FLOW MULTIPLES?
Cash Flow multiples use an estimate of Cash Flow, such as EBITDA, Operating Cash Flow, Free Cash
Flow, and Levered Free Cash Flow, as a valuation indicator. These multiples are often superior to
Earnings multiples because they ignore a lot of the idiosyncrasies of accrual-based accounting and are
therefore less subject to management manipulation. (Note that EBITDA ignores Capital Expenditures,
which are indeed a Cash outflow. Thus in many instances Comps will use (EBITDA Capital
Expenditures) as the Cash Flow estimate).
Many times in practice, the reciprocal of these multiples are used to produce Cash Flow Yields, which
are compared against treasury yields and dividend yields as a valuation yardstick.
PITFALLS TO AVOID WHEN USING COMPS:

Avoid these typical pitfalls when building a Comps analysis:

Inappropriate peer universe selected

One-off and recurring items included in historical/projected EBITDA and EPS
Wrong multiple selected for valuation

Again, remember the mnemonic, C.V.S.

Confirm relevant peer universe

Validate key fundamental metrics
Select appropriate multiple for valuation

STEPS TO REMEMBER FOR EXECUTING A COMPS VALUATION

1.
2.
3.
4.
5.
6.

Select a Peer Universe: Pick a group of competitor/similar companies with comparable

industries and fundamental characteristics.
Calculate Market Capitalization: It is equal to Share price x Number of Shares Outstanding
Calculate Enterprise Value: Market Capitalization + Debt + Preferred Stock + Minority
Interest (less common) Cash
Historical & Projected Financials: Use historical financials from filings and projections from
management, sell-side equity analysts, etc.
Spread Multiples: Using Market Capitalization, Enterprise Value and historical/projected
financials, spread (calculate) EV/EBITDA and P/E multiples.
Value Target Company: Pick the appropriate benchmark valuation multiple for the peer
group, and the value the target company based on that multiple. Typically, an average or
media is used.

SOURCES OF INFORMATION NEEDED FOR COMPS

Peer Universe: Company filings, Research Reports, Bloomberg, or FactSet

Historical Financial Results: SEC.gov has company annual reports (10-K), Quarterly reports
(10-Q), and (where available) investor Prospectuses.
Financial Projections: Management estimates, sell-side equity analyst estimates, and/or
internal estimates generated by the bank.

Peer Universe
In order to spread (calculate) comps, you must find similar companies that operate in the same
industry as the company you are trying to value.
Once again, remember C.V.S.: Confirm relevant peer universe. Validate key fundamental metrics.
Select appropriate multiple for valuation.
Picking a Peer Universe
Choosing a relevant peer universe for valuation is usually done in one of two ways:
1.

2.

Your investment banking deal team or Managing Director (MD) will instruct you as to which
comparable companies to use. For example, the MD might say, Use the following 10
companies in this analysis. The Management team of the company usually has the best
insight into the true competition in the marketplace, and is therefore usually the best
resources, but it is the job of the investment bankers to figure this out on their own.
Run a search using bank resources (such as Bloomberg, FactSet, and Analyst Reports; see
below) and screen the result set for relevance.

WHAT RESOURCES CAN BE USED TO FIND PEERS?

Some of the best resources include the following:

Company Filings: A primary source for finding peer companies is in company filings (10Ks,
10Qs, Prospectuses) in the Competitors section. These filings can be found at the SEC
website (http://www.sec.gov/).
Sell-side Equity Analyst Research Reports: Sell-side research reports are an excellent
source of comparable companies. Usually, an initiation report or a lengthy industry report will
have a fairly complete list of peer companies. This provides a good point of reference for what
other Wall Street analysts believe to be the target companys relevant peer universe.
Bloomberg: A very useful tool for finding peers is the Supply Chain page on Bloomberg for a
given company. To use this tool, type <<Ticker>> Equity SPLC <GO>. The page provides a
quick snapshot of a companys suppliers, customers and peers. Below is an example sample
screen shot for Apple Corporation (AAPL). The peer companies are shown at the bottom of
the page. The suppliers and customers should also be examined for possible inclusion in the
peer universe.

It is important to note that you will almost never find a perfect comparable company, because
companies are very similar to snowflakes no two are ever exactly alike. However, you will be
able to narrow down your search using the characteristics such as Sector, Products &
services sold, Customers base, Distribution channel, and Geography. Some examples of
nearly perfect comparable companies are: Pizza Hut and Dominos, Home Depot and Lowes,
or Pepsi and Coca-Cola. These are very similar (not identical!) companies that overlap very
well in terms of all of the relevant factors: geography, products/services, customers, and
distribution channel.
Market Capitalization (Market Value) & Enterprise Value
Once you have selected a relevant peer universe, the next step is to find the necessary
financials to spread (calculate) your multiples. Bankers will typically use database resource

such as Capital IQ and FactSet in order to pull this information quickly. This should be
checked against the actual GAAP data released in company 10-Qs and 10-Ks filed with the
SEC, because these datasets often include errors or questionable assumptions/adjustments.
(In that respect, it often is best to gather the data from the SEC directly when running a
comparable analysis.)
Necessary financials typically include the following information:

Market Capitalization (Stock Price x Shares Outstanding)

Enterprise Value (Market Value + Net Debt + Preferred Stock + Minority Interest
Cash)
Earnings Per Share (EPS, Net Income/Shares Outstanding)
Earnings before Interests, Taxes, Depreciation, and Amortization (EBITDA)

Here is an example of a final output from a Comps Analysis. The key financial inputs to this analysis
will then be discussed:

Market Capitalization (Market Value)

Market Capitalization represents the total equity value of a company, and does not reflect
managements allocation of capital structure among all forms of financing (such as equity, debt,
preferred stock, etc.). It is a useful representation of valuation for common stock investors because
they typically do not purchase a majority-owned stake in the company, and therefore only have access
to the earnings available to common shareholders.
The formula for calculating Market Capitalization is:
Market Capitalization = Stock Price x Shares Outstanding
Stock price is the price per common share. It is obtained using any financial software (Thomson,
Bloomberg, CapIQ) or reliable Internet pricing service (Yahoo Finance, Google Finance). (Be sure to
verify that price is the closing price as of the analysis date.)
There are two types of Shares Outstanding: Basic and Diluted. Basic shares outstanding can be
obtained from the first page of a companys 10-K or 10-Q. Diluted shares outstanding account for the
conversion of options, warrants and convertible preferred stock and prevents a possible underestimate
of valuation caused by using basic shares outstanding. Diluted shares outstanding can be obtained
from the EPS footnotes of a companys financials, and can also be calculated directly using footnotes
to the financials that list management stock options as well as warrants and convertible preferred
stock.
Enterprise Value

Enterprise Value (EV) represents the total value of a company and incorporates all of the components
of managements allocation of the capital structure equity, debt, preferred stock, etc. It is a useful
representation of valuation for strategic and private equity investors because it represents the takeover
value of the company (prior to any control premium for the acquisition).
The formula for calculating EV is:
EV = Market Capitalization + Debt + Preferred Stock + Minority Interest Cash
Lets look briefly at what each of these components of EV refers to and how they are calculated.
Market Capitalization
Market Capitalization, as defined earlier (Stock Price x Shares Outstanding), refers to the total
equity value of the company.
It can be defined using Basic shares outstanding or Diluted shares outstanding.
Debt

Includes short and long-term debt, as listed on the companys balance sheet, as well as
current portions of long-term debt (listed in the Current Liabilities section of balance sheet).
Each line item of debt will generally be footnoted with specific terms of the debt arrangement
given.

Preferred Stock
Listed in the Equity section of the balance sheet, Preferred Stock is the special tranche of the
capital structure that has some debt-like qualities (like paying interest) and some equity-like
qualities (often convertible into shares, and sometimes has voting rights alongside common
equity holders).
One include: mandatorily redeemable and convertible preferred where conversion price >
stock price.
Minority Interest (What is it and why do we include it?)

Minority interest is the equity interest that other entities have in a division (subsidiary) of the
company. This will occur whenever the company owns more than 50% but less than 100% of
the equity in a subsidiary. The company has control over the subsidiary, but doesnt own all of
it.
These subsidiaries will have financial results that are fully consolidated into the companys
financial results. Therefore, financial results such as Sales, EBITDA, Earnings, etc. that are
attributable to other owners will be included in the valuation metrics. The numerator of the
calculation should therefore include these minority stakes in the subsidiaries as well.
For accounting purposes, Minority Interest is treated as a liability on the Balance Sheet and
this liability amount should be added into the EV calculation.

WHY IS CASH DEDUCTED IN THE ENTERPRISE VALUE CALCULATION?

Cash is subtracted out of Enterprise Value because excess Cash is considered a non-operating asset,
and could be used to pay down part of the companys debt immediately, which would reduce the
Enterprise Value of the Company. (Note that the definition of excess cash is somewhat loose, as it
refers to cash that is not needed to conduct the operations of the business; a simplifying assumption in
most cases is to count all Cash as excess Cash.)
Historical & Projected Financials
Two fundamental metrics will always need to be calculated and input into the analysis before the
Comps can be spread: 1) EPS and 2) EBITDA. These form the denominators of the multiples used in
the analysis. Each of the examples given below consists of a historical financial result (2011 in this
example) and projected (2012E & 2013E) financial result.

HISTORICAL EPS
Historical EPS can be obtained directly from a companys income statement in the 10-K, 10-Q or most
recent earnings press release. Note, however, that Historical EPS will often need to be adjusted for
non-recurring items such as one-off charges (restructuring), extraordinary gains/losses, etc. Often,
management details adjustments in company press releases. These press releases can be found in
the Investor Relations section of company website, or via footnotes or the Management Discussion &
Analysis (MD&A) section of 10-K and 10-Q filings.
These items need to be added on a pre-tax basis for above-the-line items (items that appear before
the Taxes line item in financial statements, such as Revenue, Gross Profit, and Operating Profit.) If the
adjustments are to a below-the-line item, use the effective tax rate to determine the relevant pre-tax
amount. For adjustments to Net Income, use the effective tax rate on all pre-tax items to determine the
appropriate after-tax amount.
PROJECTED EPS
Projected EPS can be derived in several different ways:

Management estimates
Consensus analyst estimates from aggregators such as Thomson One, Capital IQ or Zacks
Individual sell-side research analysts
Your own financial model (this is rare for an initial cut at a Comparable Companies Analysis)

EBITDA
EBITDA is calculated using the following formula:
EBITDA = EBIT (Operating Profit) + Depreciation + Amortization
Spread Multiples
The next step after collecting the relevant peer universe and locating the necessary financials for each
peer is to start spreading the key trading multiples in other words, calculating and displaying them
in an easy-to-read fashion, typically in a spreadsheet. This approach allows users to easily see the
valuation calculations across your custom-defined peer universe.
The Comps table should include Mean, Median, Min and Max statistics for each metric in each year to
provide a valuation range for the company you are valuing.
VALUE TARGET COMPANY
The final step, once multiples for the peer universe have been spread, is to use this information to
determine valuation. With the valuation metrics calculated as described, we can use the multiples of
the peer universe to determine the valuation of the target company.

Lets look at an example:

COMPANY F HAS AN ESTIMATE EPS OF $1.50 IN 2012. HOW MUCH IS ITS STOCK WORTH
USING THE COMPS GIVEN?
The calculation is as follows:

The Comps set given is trading at 12.4x (median) 2012E Earnings Per Share.
12.4 x $1.50 = $18.60. (P/E multiples gives us Market Value Per Share, so we are finished!)

COMPANY F HAS AN ESTIMATED EBITDA OF $77 (MILLION) IN 2012. HOW MUCH IS ITS STOCK
WORTH USING THE COMPS GIVEN?
The calculation is as follows:

The Comps set given is trading at 5.4x (median) 2012E EBITDA.

5.4 x $77 million = $415.8 million. (This is the Enterprise Value; we need to back out Net Debt
to get to Market Capitalization. The difference between the EV and Market Capitalization
given for Company F must equal Net Debt.)
$415.8 million ($417 million - $422 million) = $415.8 million + $5.0 million = $420.8 million.
(This is Market Capitalization; we need to divide by Shares Outstanding to get the Share
Price.)
$420.8 million/30.2 million = $13.93

VALUATION CONCLUSION
Based on comparable company analysis, Comp F is worth between $13.93 - $18.60 based on
2012E P/E and EBITDA multiples of public competitors.