Comparable company analysis values a company by comparing it with similar listed companies on ratios such as price-to-earnings and EV/EBITDA. If peers trade at 25 times earnings and the company earns Rs 20 a share, the method points to a fair price near Rs 500. It is fast and based on real market prices. It only works if the peer group is chosen honestly.
Comparable company analysis, or comps, values a business by looking at what the market pays for similar businesses. There is no ten-year cash flow forecast. The analyst finds a group of listed peers, works out the multiples they trade at, and applies those multiples to the company in question. Investment banks use it to price IPOs and mergers. Retail investors use it, often without naming it, every time they ask whether a stock is cheap against its sector.
How it works, step by step
The first step is picking the peer group. The companies should be in the same industry, of similar size, with similar growth and margins. A small regional cement maker is not a peer for the country's largest one, even though both sell cement. Five to ten peers is typical.
The second step is gathering the numbers for each peer: market cap, net debt, revenue, EBITDA, net profit and book value. These come from the latest annual report and the last four quarters.
The third step is working out the multiples. The most used is the P/E ratio, price divided by earnings per share. EV/EBITDA is enterprise value divided by operating profit before depreciation. EV/Sales is used for companies that are not yet profitable. The price-to-book ratio is used for banks and finance companies.
The fourth step is applying the peer median, not the average, to the target's own numbers. The median is used because one peer at a wild multiple would otherwise skew the result.
A worked example
Suppose a mid-sized auto parts maker earns Rs 20 per share, and its three closest listed peers trade at P/E ratios of 22, 25 and 28. The median is 25, which gives an implied value of Rs 500 a share.
Cross-check with EV/EBITDA. Peers trade at a median of 12 times. The company's EBITDA is Rs 400 crore, so its implied enterprise value is Rs 4,800 crore. Subtract net debt of Rs 200 crore to get an equity value of Rs 4,600 crore. With 10 crore shares outstanding, that is Rs 460 a share.
The two methods give Rs 460 to Rs 500. If the stock trades at Rs 350, it looks cheap against its peers. If it trades at Rs 650, the market either expects faster growth than the peers or is overpaying. Either way, the next job is to find out why.
Where it goes wrong
The peer group is the weak point. Pick peers that trade at high multiples and any company looks cheap. It is easy to do this without noticing. The method also assumes the peers are fairly valued. In a bubble, every company in a sector can be expensive, and comps will say each one is fairly priced against the others. Multiples based on last year's earnings miss a company about to grow much faster or slower than the group. And accounting choices, such as how leases are treated, can make two similar businesses look different on EBITDA.
Comps against intrinsic value
Comps is a relative method. It says what a company is worth next to others, not what it is worth on its own. Intrinsic value methods such as discounted cash flow try to answer the second question. Serious analysts run both and look for a gap. If a DCF says Rs 600 and comps say Rs 460, the gap is a question to dig into, not an answer. The practical guide to calculating intrinsic value covers the other side of that comparison, and how to use the P/E ratio covers the most common multiple in more depth.
FAQs
Which multiple should be used?
It depends on the industry. P/E suits most profitable companies. EV/EBITDA suits capital-heavy businesses with different debt levels. Price-to-book suits banks and NBFCs. EV/Sales suits loss-making growth companies.
How many peers are needed?
Enough to get a meaningful median, which usually means at least five. Fewer than three is a guess.
Where do Indian investors get the data?
Company filings on the NSE and BSE websites, annual reports, and the investor presentations most listed companies publish each quarter.
Can comps be used for an unlisted company?
Yes. That is one of its main uses. It prices IPOs and values startups against listed companies in the same business, usually with a discount for the lack of liquidity.