What it means
The idea is simple: similar businesses should be valued in similar ways. If comparable listed companies trade at nine times their earnings before interest, tax, depreciation and amortisation (EBITDA), a similar company with lower risk might be worth roughly the same multiple.
The first step is choosing the peer group. Good comparables share the same industry, a similar size, similar growth and profit margins, and similar geography, and a typical analysis uses between five and fifteen of them.
Next, the analyst gathers each peer's market value and key financial figures, and calculates multiples. Common ones are enterprise value to EBITDA, enterprise value to revenue and price to earnings, and the right choice depends on the sector.
The multiples are then summarised, usually by the median because it is less distorted by outliers, and applied to the target's own figures. The result is an implied value, often presented as a range.
The method has limits. Market prices reflect sentiment as well as fundamentals, no two companies are exactly alike, and private companies usually receive a discount for being harder to sell.
Analysts therefore treat the result as a cross-check on other methods, such as a discounted cash flow, and not as a final answer. The more carefully the peers are chosen and adjusted for one-off items, the more useful the answer will be.
In practice
Real-world examples
Example 1
A private equity firm considers buying a regional logistics company. It compares the target with six listed transport firms and uses the median multiple to set an opening offer range. The firm repeats the exercise whenever market conditions change. He then adjusts for the target's smaller size and lower growth.
Example 2
A founder preparing to raise money looks at the revenue multiples of listed software companies of similar growth. She uses them to support her valuation argument, while accepting that a young private company will usually be worth less. She also shows a lower multiple to reflect the extra risk.
Example 3
A company's board commissions a fairness opinion before a merger. The adviser presents comparable company analysis alongside other methods to show that the price is within a reasonable range. The board records the analysis in the minutes alongside the other valuation evidence.
Think of it
Comps valuation is like pricing your house based on what similar homes in the neighborhood sold for.
Formula
Calculation
Implied enterprise value = Target's metric x Median peer multiple
Implied equity value = Implied enterprise value - Net debt
Five peers trade at enterprise value to EBITDA multiples of 7x, 8x, 9x, 10x and 11x. The median is 9x. The target company has EBITDA of $5,000,000, so implied enterprise value = $5,000,000 x 9 = $45,000,000. With net debt of $10,000,000, implied equity value = $45,000,000 - $10,000,000 = $35,000,000.Case study
Seen in the real world
Ridgeway Packaging is an illustrative, fictional manufacturer that wanted to sell a minority stake. The owners assumed it was worth $60,000,000 because a competitor had recently been in the news at a high price.
An adviser built a list of six listed packaging companies of broadly similar size and calculated EV to EBITDA multiples ranging from 6.5x to 9.5x, with a median of 8x. Ridgeway's EBITDA was $6,000,000, so the implied enterprise value was $48,000,000, and net debt of $8,000,000 left equity of $40,000,000.
The owners were disappointed, but they used the analysis to set a realistic range of $40,000,000 to $46,000,000. In this illustrative story the stake was sold within that range, and the owners noted that the realistic number made the negotiation shorter. They also asked the adviser to update the peer list before any future sale. In their next board meeting they agreed to refresh the analysis each year, so they would always know a defensible range for the business.
Watch out
Common mistakes
- Choosing peers because they are well known rather than because they are genuinely similar.
- Using the average when one extreme multiple distorts the result, instead of the median.
- Applying a listed company multiple to a small private company without a discount for size and illiquidity.
Questions
People also ask
Which multiple should I use?
It depends on the industry, and analysts often use EV to EBITDA for mature businesses, EV to revenue for high-growth firms with little profit, and price to earnings for stable profitable ones. The chosen multiple should match what really drives value in that sector.
How is it different from precedent transactions?
Comparable company analysis uses current trading values of listed peers, whereas precedent transactions use prices paid in actual past takeovers and so include a control premium.
How many comparables do I need?
Usually five to fifteen, enough to see a pattern but few enough to be genuinely similar. If the peer group is too small, a single odd company can swing the result.