What it means
If a company's rivals, of similar size, growth and profitability, all trade at eight to ten times EBITDA, a buyer of the company will expect to pay, and a seller will expect to receive, something in that range. Comparable company analysis makes the expectation systematic.
The method proceeds in steps. Select the peer group: companies in the same industry, with similar business models, size, growth, margins, geography and capital structure, as far as such companies exist; typically five to fifteen.
Gather their data: market capitalisation, net debt, and the financial measures for the last twelve months and the next one or two forecast years from analyst consensus. Calculate the multiples: enterprise value (market capitalisation plus net debt plus minority interests plus preferred stock minus associates) divided by EBITDA, EBIT or revenue; equity value (market capitalisation) divided by net income (the price/earnings ratio) or book value.
Analyse the range: the median, the quartiles, and the reasons for outliers (a peer with a pending takeover, a one-off in its earnings, a different growth profile). Apply to the subject: multiply its EBITDA (or other measure), normalised for one-offs and for differences in accounting, by the selected range of multiples to give a range of enterprise values; subtract the subject's net debt to give equity value.
The choice of multiple depends on the industry and the subject. EV/EBITDA is the workhorse because it is unaffected by capital structure, depreciation policy and tax; EV/EBIT where capital intensity varies; EV/revenue for loss-making or early-stage companies; price/earnings for financial companies and mature businesses; price/book for banks and asset-heavy companies; and industry-specific measures (EV per subscriber, per bed, per barrel) where they capture value drivers.
Forward multiples (on next year's forecast) are generally preferred to trailing ones because value depends on the future. Judgement is required at every stage.
No two companies are identical, and the analyst adjusts: a subject with faster growth than its peers deserves a higher multiple; one with lower margins, more leverage or a weaker market position deserves a lower one. Private companies are typically valued at a discount to listed comparables for illiquidity and size, commonly 20% to 35%.
Control premiums are not included in trading comps (which reflect minority share prices) and are added, or precedent transaction multiples are used, when valuing a controlling stake. The method's strength is that it reflects what investors are actually paying now, and its weakness is the same: if the market is over- or under-valuing the sector, the comps will be too.
Analysts therefore triangulate with discounted cash flow and precedent transactions, and present a range with the reasons for the position within it.
In practice
Real-world examples.
Example
An investment bank values a retailer for an IPO at 14 to 16 times forward earnings, the range at which its listed peers trade, less a discount to attract investors.
Example
A start-up is valued at 8 times revenue by reference to listed software companies with similar growth, since it has no earnings to which an earnings multiple could apply.
Example
A private equity firm checks its DCF valuation of a target against comps and finds the DCF 20% higher, prompting a review of the forecast.
Think of it
“Comps valuation is like pricing your house based on what similar homes in the neighborhood sold for.
Formula
Calculation
Enterprise Value (peer) = Market capitalisation + Net debt + Minority interests + Preferred equity minus Associates and investments
EV/EBITDA = Enterprise value / EBITDA (trailing or forward)
Implied Enterprise Value (subject) = Subject's EBITDA x Selected multiple
Implied Equity Value = Implied enterprise value minus Subject's net debt
Private company discount: Implied equity value x (1 minus Discount)
Worked example. A privately owned packaging manufacturer with EBITDA of $12,000,000 (normalised: the owner's above-market salary of $400,000 added back and a one-off insurance recovery of $600,000 removed), net debt of $18,000,000, revenue of $95,000,000 and growth of 5% a year is valued for a possible sale.
Peer group: six listed packaging companies.
- Peer 1: EV $840,000,000; EBITDA $105,000,000; EV/EBITDA 8.0; growth 4%
- Peer 2: EV $1,250,000,000; EBITDA $138,000,000; EV/EBITDA 9.1; growth 7%
- Peer 3: EV $410,000,000; EBITDA $59,000,000; EV/EBITDA 6.9; growth 2%
- Peer 4: EV $2,100,000,000; EBITDA $200,000,000; EV/EBITDA 10.5; growth 9% (and a pending takeover approach; excluded as an outlier)
- Peer 5: EV $620,000,000; EBITDA $76,000,000; EV/EBITDA 8.2; growth 5%
- Peer 6: EV $930,000,000; EBITDA $124,000,000; EV/EBITDA 7.5; growth 3%
Excluding Peer 4: multiples 6.9, 7.5, 8.0, 8.2, 9.1; median 8.0; range 6.9 to 9.1. The subject's growth (5%) and margins (12.6% EBITDA margin against a peer median of 12.0%) are around the median; it is much smaller than any peer.
Implied enterprise value at the median: $12,000,000 x 8.0 = $96,000,000. Range: $82,800,000 (6.9x) to $109,200,000 (9.1x).
Less net debt $18,000,000: implied equity value $78,000,000 at the median; range $64,800,000 to $91,200,000.
Private company and size discount of 25%: equity value $58,500,000 at the median; range $48,600,000 to $68,400,000.
Cross-check with precedent transactions: three acquisitions of private packaging companies in the past two years at 7.0x, 7.8x and 8.5x EBITDA (these include control premiums but reflect private company discounts): median 7.8x, implying EV $93,600,000 and equity $75,600,000 for a controlling stake. Discounted cash flow at a 9.5% WACC and 2% terminal growth: EV $101,000,000, equity $83,000,000.
Conclusion presented to the owner: a trade buyer acquiring control might pay $70,000,000 to $85,000,000 for the equity; a financial buyer perhaps $60,000,000 to $75,000,000; the owner's expectation of $100,000,000 (based on "ten times") is above every method's range and rests on the excluded peer's takeover-inflated multiple.Case study
Seen in the real world.
A family-owned regional bakery chain received an unsolicited offer of $40,000,000 and asked its adviser whether the price was fair. The adviser's comparable company analysis started with listed food producers, which traded at 10 to 12 times EBITDA, and the family concluded that the offer, at 6.5 times its $6,200,000 EBITDA, was far too low. The adviser then refined the analysis.
The listed peers were national brands with 15% margins and 6% growth; the bakery had 9% margins, 2% growth, a single region and dependence on two supermarket customers for 60% of sales. Peers with more similar profiles, smaller listed bakeries and regional food companies, traded at 6 to 8 times. Precedent transactions for regional bakeries had been at 5.5 to 7 times.
Applying a private company discount to the refined peer range gave an equity value of $33,000,000 to $42,000,000. The offer was at the upper end.
The family negotiated a modest increase to $43,000,000 on the strength of a new contract, and accepted. The adviser's summary was that the first peer set had told the family what a different business was worth, and that the work of comparable analysis was in the word comparable.
Watch out
Common mistakes.
- Selecting peers by industry label alone, without matching size, growth, margins and business model, which produces a multiple for a different kind of business.
- Applying listed company multiples to a private company without a discount for illiquidity and size, or applying trading multiples to a controlling stake without considering the control premium.
- Using unadjusted EBITDA. Owner compensation, one-offs, related-party arrangements and accounting differences must be normalised before a multiple is applied.
Questions
People also ask.
What multiple should be used?
EV/EBITDA for most industrial and service companies; EV/revenue for loss-making or early-stage businesses; P/E or price/book for financial companies; industry-specific multiples where they capture the value driver. Forward multiples are preferred where forecasts exist.
How many comparable companies are needed?
Enough to establish a range and a median, typically five to fifteen. Fewer than four makes the result unreliable; more than twenty usually means the set is too broad.
How does comparable company analysis differ from precedent transactions?
Trading comps use current market prices of minority shares in listed peers. Precedent transactions use prices actually paid for control of similar companies, which include control premiums and reflect conditions at the time of each deal.
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