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Comparable company analysis

Question​

What is the market paying for similar companies today, and where does the target sit in that distribution?

Inputs​

InputSource
Peer setCompanies with the same business model, scale, geography, and capital intensity
Operating metrics (revenue, growth, gross margin, operating margin)Latest filings or trailing-twelve-month data
Cash flow metrics (free cash flow, free cash flow margin)Cash flow statements
Capital structure (market capitalization, net debt)Market prices, balance sheet
Valuation multiples (enterprise value over revenue, enterprise value over operating profit, price over earnings)Computed from the above

Standardize the period. All numerator and denominator data must come from the same window — trailing twelve months for trailing multiples, calendar-forward for forward multiples. Mixing kills the comparison.

Procedure​

  1. Define the peer group. Three to ten companies that share the target's business model, growth profile, and operational scale. Better five tight peers than ten loose ones. Document why each company is in or out.
  2. Pull operating metrics. Revenue, revenue growth, gross margin, operating profit, operating margin. Source each number with the date and the file or system it came from.
  3. Calculate efficiency ratios. Every ratio uses revenue (or another stated denominator) consistently. Margins are gross profit divided by revenue, not by anything else.
  4. Pull capital structure. Market capitalization equals share price times diluted shares. Net debt equals total debt minus cash. Enterprise value equals market capitalization plus net debt.
  5. Calculate multiples. Enterprise value divided by revenue. Enterprise value divided by operating profit. Price divided by earnings. Calculate consistently across every peer.
  6. Compute the distribution. Maximum, seventy-fifth percentile, median, twenty-fifth percentile, minimum — for every comparable ratio and multiple. The distribution is the answer. The average is a trap.
  7. Position the target. Where does the target's multiple sit in the peer distribution? At the seventy-fifth percentile, the market treats it as premium. At the twenty-fifth, discount. The why matters more than the where.
  8. Document methodology. Period, units (millions or billions), data sources, definitions of every metric. A reader who did not build the model must be able to re-build it from the notes.

Gates​

  • The peer set mixes business models — multiples are not comparable
  • Numerator and denominator periods do not match (trailing data divided by forward data)
  • Multiples reference negative denominators (a negative operating profit gives a meaningless ratio)
  • Statistics are computed on absolute size metrics (revenue, market cap) which are not comparable
  • An input has no source comment
  • The output is an average instead of a distribution

Output​

A peer table with operating metrics, capital structure, and valuation multiples, plus a five-row statistics block (max, seventy-fifth, median, twenty-fifth, min) for every comparable metric. The target sits in the distribution with a reason for the position. The whole thing is staged for review.

Common Mistakes​

  • Computing the average of percentages — the median is the right central tendency
  • Comparing companies on absolute size — the multiple is what is comparable, not the headline
  • Forcing a comp because the analyst likes the company — better to exclude than to fake comparability
  • Hardcoding the multiple instead of dividing the right cells — the output stops updating
  • Using book values for the capital structure — multiples then mean nothing
  • Ignoring leverage differences across peers (the enterprise value over operating profit corrects for capital structure; price over earnings does not)

Adjacent Methods​

Questions​

Does every peer share the same business model and growth profile?

  • Are numerator and denominator from the same period?
  • Am I reporting a distribution, not just an average?