What it means
The logic mirrors how people value a house: look at what similar houses nearby sold for and adjust. In business valuation, the analyst picks a group of listed companies with similar activities, size, growth and risk.
Each peer's market price is turned into a multiple, which is a ratio that makes companies of different sizes comparable. The most common multiple is enterprise value to EBITDA.
Enterprise value is the price of the whole business including debt, and EBITDA (earnings before interest, tax, depreciation and amortisation) is a rough measure of operating profit. Other popular multiples include price to earnings, enterprise value to revenue, and price to book value.
Using the analysis involves four steps. The analyst chooses the peer group, collects each company's financial data and market value, calculates the multiples, and then applies a central figure, usually the median, to the target company's own earnings.
The median is preferred because it is not distorted by one unusually high or low peer. Choosing the peers is where judgement matters most.
Companies must be truly comparable in business model, geography, growth and profitability, otherwise the answer will mislead. Analysts also adjust for one-off items and differences in accounting so that the numbers can be compared on a like-for-like basis.
The approach is valued for being grounded in real market prices, but it has limits. It reflects the market's mood, so when the whole sector is overpriced or underpriced the valuation will be too.
It also struggles with companies that have no close peers, which is why it is often used alongside discounted cash flow valuation. Private company valuations often add a discount, because shares that cannot easily be sold are worth less than listed ones.
That adjustment, sometimes called a liquidity discount, is a judgement call and should be stated openly.
In practice
Real-world examples.
Example
A founder preparing to sell a logistics business asks an adviser for a price range. The adviser values six listed freight companies on EV/EBITDA and applies the median to the business's earnings. The result becomes the opening point for negotiation with buyers.
Example
An equity research analyst covering retail chains builds a table of price-to-earnings ratios for ten competitors. She notices that one chain trades at half the average while growing at the same speed. She flags it as potentially undervalued and investigates why.
Example
A start-up's CFO needs to justify a valuation to a new investor in a funding round. She prepares a comparison with listed software companies at a similar stage, adjusts for size, and explains the discount applied. The investor accepts the method as a sensible starting point.
Formula
Calculation
Implied enterprise value = Median peer EV/EBITDA multiple x Target's EBITDA
Implied equity value = Implied enterprise value - Net debt
An analyst values a private software firm using five listed peers, whose EV/EBITDA multiples are 8x, 9x, 10x, 11x and 12x. The median is 10x. The target has EBITDA of $5,000,000, so the implied enterprise value is 10 x 5,000,000 = $50,000,000. With net debt of $8,000,000, the implied equity value is 50,000,000 - 8,000,000 = $42,000,000.Case study
Seen in the real world.
Kestrel Dental Group is a fictional chain of 14 clinics, used as an illustrative example. The owners are considering a sale and ask their finance manager for a valuation range. She selects eight listed healthcare services businesses and calculates their EV/EBITDA multiples, which range from 7x to 13x with a median of 9x.
Kestrel's EBITDA is $6,000,000, so the median multiple suggests an enterprise value of $54,000,000. Because Kestrel is smaller and privately held, she applies a modest discount and presents a range rather than a single figure. The owners use that range to judge offers, and the illustrative lesson is that comparable analysis gives a defensible start, not a final answer.
Watch out
Common mistakes.
- Choosing peers that only look similar. A company in the same industry but with a very different growth rate or business model can distort the result.
- Using the average instead of the median. One extreme value can pull an average far away from what is typical.
- Mixing equity-based and enterprise-based figures. A price-to-earnings ratio belongs with earnings after interest, while EV/EBITDA belongs with earnings before it.
Questions
People also ask.
How many comparable companies are enough?
There is no fixed number, but most analyses use roughly five to fifteen. Too few makes the result fragile, and too many may include firms that are not truly comparable.
How is this different from precedent transactions?
Comparable company analysis uses current trading prices of listed peers. Precedent transaction analysis uses prices actually paid in past acquisitions, which usually include a premium for control.
Can it be used for a loss-making company?
Earnings multiples do not work when earnings are negative, so analysts switch to revenue multiples or other measures. The results are usually less precise.
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