Valuation: Comparable Companies Analysis
Many small business owners - or large business owners for that matter - wonder what their business is worth. For those owners who have money and are particularly curious, they can hire a company valuation specialist to do a valuation just an appraiser would could come an do an appraisal of a house. For those who not only want to get a valuation for their company but who also want to understand the mendasar value drivers of their business, they can learn to do that valuation themselves. One such valuation method is the comparable companies analysis. Let's have a look at what it involves.
The comparable companies analysis is one of the most common valuation methods used on Wall Street. This analysis uses the market prices of actively traded common stocks of publicly-traded companies with similar business risks and returns to estimate the market value of a business under consideration.
These comparable companies are known as "comps." Finding the appropriate comps for a particular company is an art form and is the key to using the valuation technique effectively.
Picking Comps
It is very important to pick companies as similar as possible to the subject company. The key measures of a potential comp's comparability are industry segment, growth prospects and operating margins.
The major financial characteristics to consider when picking comps are size (revenues and operating earnings) and profitability. The major business and operating characteristics to consider are industry (SIC codes), products, geographic market and customers.
There are many resources you can use to go about finding comps. Once you have identified one public company as a good comp, you can look at some of the publicly-filed documents such as 10-Ks or proxies, which will often have sections on the company's competitors. These sections are often a good place to find new comps. As new comps are found, you can repeat this process to find additional ones.
In addition to SEC filings like the 10-K, there are a lot of online databases with tools that will help identify a set of comps for you. Unfortunately, many of these databases require a subscription, so few people outside of an investment bank have access to them.
One free online database, though, is Yahoo Finance. This is often the perfect place to start looking for comps because it has links that identify competitors and also has links to SEC filings. Yahoo will also do a quick multiples analysis of these competitors, which will be our next step.
So when do you have enough comps? The answer to this question will vary depending upon the company you are trying to analyze. You should try to get as many comps as possible to get a more accurate analysis, but for some industries, there just aren't a lot of public companies available.
It is hard to do a credible comparable companies analysis with fewer than four comps, but sometimes you just have to settle for fewer. On the other hand, pulling more than 30 comps may give you a more accurate reading, but it can be a pain pulling all the financial information necessary to do the analysis.
Crunching the Multiples
At the heart of the comparable companies analysis is the use of multiples to calculate valuation. Multiples are used to assign value in the analysis. They are relationships between value and the current financial results of a company. Multiples hinge on both the risk and a company's operating performance.
Perhaps the most commonly known multiple is the price to earnings ratio or P/E multiple. It is derived by dividing the stock's current market price by the company's earnings per share (EPS) over the last twelve months. The higher the company's expected earnings growth and the lower the perceived risk of the company, the higher the multiple.
The P/E multiple is just one of many multiples used in a typical comps analysis. It is best to look at several multiples in the analysis to determine which ones the market seems to use to value the comp set.
Types of Multiples
The are two general types of multiples - market value of equity multiples and enterprise value multiples. The market value of equity is the value owned by the company's common stockholders as minority interests in a publicly-traded company on a fully-distributed basis. This value is what's left after paying off the company's debt. It can be calculated simply by multiplying the current stock price by the number of fully diluted shares outstanding.
A company's enterprise value, however, also includes preferred stock, minority interests and net debt. The simplified version of this formula is:
Enterprise Value = Market Value of Equity + Preferred Stock + Minority Interests + Net Debt
The more detailed formula is a bit more complicated:
Enterprise Value = (Stock Price * Fully Diluted Shares Outstanding) + Preferred Stock + Minority Interests + (Long-term Debt + Short-term Debt - Cash & Cash Equivalents)
Enterprise value multiples use operating statistics that are before net interest expense and taxes. The reason for this is that the capital structure of the company (how much debt vs. equity it has) should not play a part in how it is valued. Therefore, interest, which would flow to debt investors, is taken out of the equation.
The comparable companies analysis is one of the most common valuation methods used on Wall Street. This analysis uses the market prices of actively traded common stocks of publicly-traded companies with similar business risks and returns to estimate the market value of a business under consideration.
These comparable companies are known as "comps." Finding the appropriate comps for a particular company is an art form and is the key to using the valuation technique effectively.
Picking Comps
It is very important to pick companies as similar as possible to the subject company. The key measures of a potential comp's comparability are industry segment, growth prospects and operating margins.
The major financial characteristics to consider when picking comps are size (revenues and operating earnings) and profitability. The major business and operating characteristics to consider are industry (SIC codes), products, geographic market and customers.
There are many resources you can use to go about finding comps. Once you have identified one public company as a good comp, you can look at some of the publicly-filed documents such as 10-Ks or proxies, which will often have sections on the company's competitors. These sections are often a good place to find new comps. As new comps are found, you can repeat this process to find additional ones.
In addition to SEC filings like the 10-K, there are a lot of online databases with tools that will help identify a set of comps for you. Unfortunately, many of these databases require a subscription, so few people outside of an investment bank have access to them.
One free online database, though, is Yahoo Finance. This is often the perfect place to start looking for comps because it has links that identify competitors and also has links to SEC filings. Yahoo will also do a quick multiples analysis of these competitors, which will be our next step.
So when do you have enough comps? The answer to this question will vary depending upon the company you are trying to analyze. You should try to get as many comps as possible to get a more accurate analysis, but for some industries, there just aren't a lot of public companies available.
It is hard to do a credible comparable companies analysis with fewer than four comps, but sometimes you just have to settle for fewer. On the other hand, pulling more than 30 comps may give you a more accurate reading, but it can be a pain pulling all the financial information necessary to do the analysis.
Crunching the Multiples
At the heart of the comparable companies analysis is the use of multiples to calculate valuation. Multiples are used to assign value in the analysis. They are relationships between value and the current financial results of a company. Multiples hinge on both the risk and a company's operating performance.
Perhaps the most commonly known multiple is the price to earnings ratio or P/E multiple. It is derived by dividing the stock's current market price by the company's earnings per share (EPS) over the last twelve months. The higher the company's expected earnings growth and the lower the perceived risk of the company, the higher the multiple.
The P/E multiple is just one of many multiples used in a typical comps analysis. It is best to look at several multiples in the analysis to determine which ones the market seems to use to value the comp set.
Types of Multiples
The are two general types of multiples - market value of equity multiples and enterprise value multiples. The market value of equity is the value owned by the company's common stockholders as minority interests in a publicly-traded company on a fully-distributed basis. This value is what's left after paying off the company's debt. It can be calculated simply by multiplying the current stock price by the number of fully diluted shares outstanding.
A company's enterprise value, however, also includes preferred stock, minority interests and net debt. The simplified version of this formula is:
Enterprise Value = Market Value of Equity + Preferred Stock + Minority Interests + Net Debt
The more detailed formula is a bit more complicated:
Enterprise Value = (Stock Price * Fully Diluted Shares Outstanding) + Preferred Stock + Minority Interests + (Long-term Debt + Short-term Debt - Cash & Cash Equivalents)
Enterprise value multiples use operating statistics that are before net interest expense and taxes. The reason for this is that the capital structure of the company (how much debt vs. equity it has) should not play a part in how it is valued. Therefore, interest, which would flow to debt investors, is taken out of the equation.
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