Trading comparables
Also known as: Comps, Peer multiples, Market approach
What the market pays for similar businesses today. The choice of peers is made before any arithmetic and is most of the valuation.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat actually happens?
The simplest way to value something is to look at what similar things sell for. A house is valued from the houses on the same street; a company is valued from the companies in the same business.
So you take a handful of listed companies that do roughly the same thing, work out what the market is paying for each unit of their profits, and apply the same ratio to the company you are valuing.
That ratio is a multiple. If similar companies trade at twelve times their profits and this one earns 50, then twelve times 50 gives 600.
All of the difficulty is in the word "similar". There is no rule for which companies belong together, and the choice moves the answer more than everything else in the analysis put together. Add two names, drop two others, and the answer changes by a fifth. Anybody reading this work will look at the list of peers first, because everybody knows that is where the judgement is.
- 1
Choosing peers1–4 days
Which companies this one belongs with — a judgement that moves the answer more than the calculations do.
- 2
Collecting the data2–5 days
Market values, net debt, pensions, leases and minorities for every peer, on a consistent basis.
- 3
Normalising2–4 days
Adjusting for different year ends, accounting choices and one-off items so the multiples compare like with like.
- 4
Applying to the target1 day
The peer multiples are applied to the target's own earnings to produce an implied range.
Is this set defensible — Anybody who will read it decides. Adding or dropping two names moves the median more than most analytical work does, which is why the set is argued about first.
Are the multiples comparable — The analyst decides. A multiple computed on a different definition of earnings is not a comparison, it is a coincidence.
Who is on the deal
| Who | Side | What they are actually for |
|---|---|---|
| The analyst | Neither | Chooses the peer set, which is the valuation rather than an input to it. |
| The market | Neither | Sets the multiples, continuously, for reasons that have nothing to do with this transaction. |
| The client | Both | Has a view about which companies it belongs with, and that view is rarely neutral. |
| Whoever reads it later | Neither | Will check the peer list first, because everybody knows that is where the judgement is. |
- Desk
- Valuation & Deal Analysis
- Answers
- What would this trade at as a listed company
- Excludes
- Any premium for control
- The judgement
- Which companies this one belongs with
- Standard multiples
- Enterprise value to earnings, and price to earnings
What decides whether it completes
Not how hard this is, and not a rating — there is deliberately no total. It says which of five blockers decides whether this transaction happens at all, in the same order on all 70 transaction types so they can be compared. This publication's own reading; see the notice below.
- Pricedecides it
- Financingbarely applies
- Approvalbarely applies
- Diligencematters
- Executionmatters
What decides it here. The peer set is chosen before any arithmetic begins, and adding or dropping two names moves the median more than the rest of the work combined. Everything after that is bookkeeping — and a multiple computed on a different definition of earnings is not a comparison at all.
3 · IntermediateHow it runs in practice
Which multiple, and why it matters
- Enterprise value to operating earnings — the standard, because it compares the whole business regardless of how it is funded. Two identical companies with different debt should have the same one.
- Price to earnings — an equity multiple, so it is affected by leverage and tax. Familiar, and it compares two things that are not the same shape.
- Enterprise value to revenue — used where there are no profits yet, and it assumes every peer converts revenue to profit at a similar rate.
- Sector-specific measures — per subscriber, per bed, per barrel. Useful and dangerous in equal measure.
Consistency, which is where most of the errors are
An enterprise value multiple must have an enterprise value on top and a pre-interest measure underneath. Putting a market capitalisation over operating earnings compares the equity's price with the whole business's profit, and produces a number that means nothing at all.
Normalising
Peers report to different year ends, use different accounting policies for leases and pensions, and have one-off items in different years. Comparing them without adjustment is comparing statements rather than businesses, and the adjustments are where the unglamorous work is.
Forward, not trailing
Multiples are usually quoted on next year's expected earnings rather than last year's reported. Markets price the future, and a company with collapsing earnings looks cheap on a trailing multiple for exactly the reason it should not be bought.
4 · AdvancedThe numbers & the documents
What a multiple actually contains
A multiple is a compressed discounted cash flow. Take a perpetuity growing at a constant rate and the price-to-earnings ratio can be written as a function of the payout ratio, the growth rate and the discount rate. Two companies trading at different multiples differ in growth, in risk, or in how much they must reinvest.
Which turns the analysis around usefully: instead of asking what multiple to apply, ask what growth and risk the observed multiple implies, and whether this company has those. That is a far harder question to fudge.
Why this excludes a control premium
These are prices at which small parcels of shares change hands between investors, none of whom can change anything. A buyer acquiring the whole company gets the ability to change the strategy, the capital structure and the management — and pays for it. That is why precedent transactions produce higher multiples, and why the two methods sit side by side rather than competing.
The honest problems
- Genuinely comparable companies are rare. Most businesses are a mixture, and the peer set is a compromise before it is anything else.
- The whole sector can be mispriced, and this method inherits that entirely — it says what the market pays, not what the business is worth.
- Selection is nearly invisible. A defensible-looking list chosen to reach a conclusion is very hard to challenge from outside.
How to read somebody else's comps page
Look at the list first, then at the dispersion. A peer set whose multiples run from six times to twenty-four has not identified comparable companies — it has produced a range so wide that the median is arbitrary. And check whether the median or the mean was used, because on a small set with one outlier those are different arguments.
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.
5 · Desk notesHow people on the deal think about it
Now say it back
Close the page and give Trading comparables in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.
- Who wants what — name both sides and what each one is actually trying to get.
- What has to happen, in order — the three or four stages, not the whole timetable.
- Where the money comes from — cash, new shares, or borrowed; somebody has to fund it.
- What kills it — the ordinary way, not the dramatic one.
Where this transaction shows up elsewhere
- EasyFairness opinionDealA narrow statement, on a stated date, about one specific offer
- MediumDiscounted cash flowDealThe only method that values the business itself
- MediumMinority stakeDealBuying part of a company without buying control — and paying less per share for exactly that reason
- MediumValuationDeskThe arithmetic underneath every transaction: discounted cash flow, comparables, precedent transactions, the buyout…