What is Comparable Company Analysis (Comps): Explained for your financial analysis

Comparable Company Analysis (Comps) is one of the most widely used valuation methods in the world of finance. It’s a relative valuation approach that involves comparing a company to other similar companies in the same industry to determine its value. The idea is simple: by comparing a company to its peers, you can estimate its value based on how much other market participants are willing to pay for similar businesses.

In this guide, we’ll walk you through the process of Comparable Company Analysis (Comps), explain its key metrics, and provide examples to help you apply it to your own investment or analysis.

What is Comparable Company Analysis (Comps)?

Comparable Company Analysis (Comps) is a method used to value a company by comparing it to other publicly traded companies that are similar in terms of size, industry, and other characteristics. This method relies on market data to estimate the value of a company based on how the market values its peers.

Why It Matters:
Comps is one of the most popular valuation techniques because it’s relatively simple, quick, and intuitive. Instead of relying solely on projections or subjective assumptions about a company’s future cash flows (like in a DCF), Comps provides a market-based approach by benchmarking a company against similar firms. The market data is readily available, making it highly useful for investors, analysts, and companies when estimating the fair market value of a business.

The Process of Comparable Company Analysis

To perform a Comparable Company Analysis (Comps), follow these general steps:

1. Select a Set of Comparable Companies (Peers)

The first step in Comps analysis is selecting a set of peer companies that are similar to the company being valued. These companies should share common characteristics such as:

Industry: Companies within the same industry (e.g., technology, pharmaceuticals, or consumer goods).

Size: Companies that are similar in terms of revenue, market capitalization, or asset size.

Geography: Companies operating in the same region or country.

Growth Stage: Companies at a similar growth stage, whether they are startups, growth companies, or mature firms.

The more similar the companies are to the company you're valuing, the more reliable the comparison will be. For example, if you're valuing a software company, you'll want to compare it to other publicly traded software companies, not to companies in unrelated sectors like retail or manufacturing.

2. Calculate Key Financial Metrics for the Comparable Companies

Once you've selected a group of comparable companies, you need to gather key financial metrics for each of them. These metrics will form the basis for your valuation. Commonly used multiples in Comparable Company Analysis include:

Price-to-Earnings (P/E) Ratio: Measures the price investors are willing to pay for each unit of earnings.
- Formula: P/E = Market Price per Share / Earnings per Share (EPS)

Enterprise Value-to-EBITDA (EV/EBITDA): Measures a company's total value in relation to its earnings before interest, taxes, depreciation, and amortization.
- Formula: EV/EBITDA = Enterprise Value / EBITDA

Price-to-Sales (P/S) Ratio: Measures the price investors are willing to pay for each unit of sales.
- Formula: P/S = Market Price per Share / Revenue per Share

Enterprise Value-to-Revenue (EV/Revenue): Measures the company’s total value relative to its revenue.
- Formula: EV/Revenue = Enterprise Value / Revenue

3. Calculate the Valuation Multiples for the Target Company

After gathering the financial metrics for the peer group, the next step is to calculate the same multiples for the company you are valuing (the "target company").

For example, if you are valuing TechX, a technology company, you’ll need to find its P/E ratio, EV/EBITDA, and P/S ratio based on its current financials (market price per share, earnings, revenue, EBITDA, etc.).

4. Apply the Multiples to the Target Company

Now that you have the multiples for both the peer group and the target company, the next step is to apply the peer group multiples to the target company’s financials to estimate its value.

Example: If the average P/E ratio of the peer group is 20x, and TechX has an earnings per share (EPS) of INR 50, the estimated value of TechX using the P/E multiple would be:
- Estimated Value of TechX = P/E Ratio × EPS
- Estimated Value = 20 × INR 50 = INR 1,000

You can do the same for other multiples like EV/EBITDA and P/S. The result will give you a range of values for the target company, depending on the multiple used.

5. Adjust for Differences Between the Companies

Once you have your range of values, you may need to make adjustments for any differences between the target company and the peer group. For instance:

Growth Rate: If the target company is expected to grow faster than its peers, you might apply a higher multiple to reflect that growth potential.

Profitability: If the target company is more profitable or has a higher margin than its peers, you might adjust the multiples upwards.

Risk: If the target company is considered riskier (e.g., due to operational challenges or market conditions), you might adjust the multiples downwards.

These adjustments ensure that the valuation is more accurate and reflects the specific characteristics of the target company.

Commonly Used Valuation Multiples

Here are the key valuation multiples that are commonly used in Comparable Company Analysis (Comps):

1. P/E Ratio (Price-to-Earnings):

The P/E ratio is one of the most widely used valuation multiples. It measures how much investors are willing to pay for each unit of earnings. It's particularly useful for comparing companies with similar earnings and growth rates.

P/E Ratio = Market Price per Share / Earnings per Share (EPS)

2. EV/EBITDA (Enterprise Value-to-EBITDA):

The EV/EBITDA ratio is commonly used for companies with significant capital expenditures or those in capital-intensive industries. It’s a good measure of how much investors are willing to pay for a company’s operating profit, regardless of its capital structure.

EV/EBITDA = Enterprise Value / EBITDA

3. P/S Ratio (Price-to-Sales):

The P/S ratio is often used for startups or companies that are not yet profitable but are generating significant revenue. It measures the value the market assigns to each unit of sales.

P/S Ratio = Market Price per Share / Revenue per Share

4. EV/Revenue (Enterprise Value-to-Revenue):

This ratio is used for companies that are in growth stages but may not yet be profitable. It helps compare a company’s value in relation to its revenue generation capabilities.

EV/Revenue = Enterprise Value / Revenue

Why Comparable Company Analysis (Comps) Matters

Simplicity and Efficiency: Comps is a relatively quick and straightforward method to determine a company’s value. You don’t need complex projections or assumptions about future cash flows, which makes it easy to apply when you're looking for a quick valuation.

Market-Based Approach: Since Comps uses market data from similar companies, it provides a real-world, market-based perspective on what investors are willing to pay for companies in a similar sector.

Industry Benchmarking: Comps allows you to compare a company against others in the same industry. It helps identify whether a company is overvalued or undervalued relative to its peers.

Flexibility: This method can be used across different industries and sectors, making it a versatile tool for valuing companies.

Real-World Example: Comps for Reliance Industries

Let’s apply Comparable Company Analysis to a real company, Reliance Industries, to see how this method works in practice.

Step 1: Select Peer Companies

Reliance Industries operates in the energy, retail, telecommunications and oil sectors. Its peers might include companies like, Indian Oil Corporation, Bharat Petroleum Corporation and Bharti Airtel.

Step 2: Gather Financial Data

You’d collect financial data for Reliance Industries and its peers, such as market price, earnings, EBITDA, and sales.

Step 3: Calculate Multiples

Let’s assume the average P/E ratio for the peer group is 18x, the average EV/EBITDA ratio is 12x, and the P/S ratio is 1.5x.

Step 4: Apply Multiples

If Reliance Industries has an EPS of INR 100, an EBITDA of INR 30,000 crore, and revenue of INR 1,00,000 crore, you can apply these multiples to estimate the value.