Comparable Company Analysis: Relative Valuation

Comparable company analysis, known as "comps" on Wall Street, is a relative valuation method that values a company by comparing it to similar publicly traded peers. Unlike intrinsic valuation methods like DCF, comps rely on what the market is currently paying for similar businesses. This practical guide shows you how to build a comp set and derive fair value.

What is Comparable Company Analysis?

Comps answer a simple question: If similar companies trade at certain valuation multiples, what should this company be worth? The logic is straightforward - if Competitor A trades at 15x earnings and your company has similar characteristics, it should trade at a similar multiple.

When to Use Comps

• Quick valuation: Faster than building a detailed DCF model
• Market sanity check: Validates or challenges intrinsic valuations
• IPO pricing: Setting prices for newly public companies
• M&A analysis: Establishing acquisition price ranges
• Sector rotation: Finding relatively cheap stocks within an industry

Step 1: Select Comparable Companies

Choosing the right peer group is crucial. Look for companies with:

• Same industry: Similar products, services, or business models
• Similar size: Revenue and market cap within a reasonable range
• Comparable growth: Similar growth rates and stage of business lifecycle
• Geographic overlap: Operating in similar markets
• Similar margins: Comparable profitability profiles

Example: Tech Software Peer Group

Valuing a mid-sized cloud software company, you might select:

• Salesforce (CRM) - Enterprise cloud software leader
• ServiceNow (NOW) - Enterprise workflow automation
• Workday (WDAY) - Enterprise HR and finance cloud
• Adobe (ADBE) - Creative and marketing cloud
• Intuit (INTU) - Small business financial software

Step 2: Gather Financial Data

For each comparable company, collect:

• Current stock price and shares outstanding
• Market capitalization
• Total debt and cash
• Enterprise value (Market Cap + Debt - Cash)
• Revenue (trailing twelve months and forward estimates)
• EBITDA (trailing and forward)
• Net income and EPS
• Growth rates

Step 3: Calculate Valuation Multiples

The most common multiples used in comps analysis:

Enterprise Value Multiples

• EV/Revenue: Enterprise Value / Revenue - useful for high-growth companies without profits
• EV/EBITDA: Enterprise Value / EBITDA - most widely used for mature companies
• EV/EBIT: Enterprise Value / Operating Income - accounts for depreciation differences

Equity Multiples

• P/E: Price / Earnings Per Share - classic valuation metric
• P/B: Price / Book Value - useful for asset-heavy businesses
• PEG: P/E / Growth Rate - adjusts for growth differences

Example: Comps Table

Step 4: Apply Multiples to Target Company

Now apply the peer multiples to your target company's financials:

Example Calculation

Target Company XYZ has:

• Revenue: $2.0 billion
• EBITDA: $400 million
• Net Income: $250 million
• Shares Outstanding: 100 million
• Cash: $300 million, Debt: $500 million

Valuation using EV/Revenue (8.5x median):

Enterprise Value = $2.0B x 8.5 = $17.0 billion

Equity Value = $17.0B - $500M + $300M = $16.8 billion

Price per share = $16.8B / 100M = $168

Valuation using EV/EBITDA (22x median):

Enterprise Value = $400M x 22 = $8.8 billion

Equity Value = $8.8B - $500M + $300M = $8.6 billion

Price per share = $8.6B / 100M = $86

Valuation using P/E (35x median):

EPS = $250M / 100M = $2.50

Price per share = $2.50 x 35 = $87.50

Step 5: Adjust for Differences

Rarely are companies perfectly comparable. Adjust for key differences:

• Higher growth: Deserves premium multiples
• Better margins: Indicates stronger competitive position
• Lower risk: More stable business warrants higher valuation
• Market leadership: Dominant players often trade at premiums
• Balance sheet strength: Lower debt justifies higher multiples

Premium/Discount Framework

If your target company grows at 25% versus the peer median of 18%, it might deserve a 15-20% premium to median multiples.

Example: If peer median P/E is 35x and target deserves 15% premium:

Adjusted multiple = 35 x 1.15 = 40.25x

Adjusted price = $2.50 x 40.25 = $100.63

Common Mistakes to Avoid

• Poor peer selection: Comparing apples to oranges invalidates the analysis
• Ignoring growth differences: Fast growers naturally trade higher
• Using outdated data: Markets change quickly; use current financials
• Relying on single multiple: Use several multiples for triangulation
• Ignoring capital structure: Use EV multiples for debt-heavy companies

Comps vs DCF: Which to Use?

Best practice: Use both methods and compare results. Significant divergence warrants investigation.

Summary

Comparable company analysis values stocks by comparing them to similar publicly traded peers. The process involves selecting appropriate comparable companies, gathering financial data, calculating valuation multiples, applying those multiples to your target company, and adjusting for differences. While comps rely on market sentiment rather than fundamental value, they provide an essential reality check and are widely used by professional investors and analysts. Combine comps with DCF analysis for a complete valuation picture.

Related reading: EV/EBITDA ratio explained, PEG ratio guide, and DCF valuation.