What you will learn
- Explain how comparable company analysis values a business
- Apply a peer multiple to a company's metric to imply a value
- Describe the strengths of comps as a market-based cross-check
- Understand the deep weakness that comps assume the peer group is fairly priced
A DCF values a company from the inside out, on its own cash flows. Comparable company analysis, often shortened to comps, takes the opposite approach. It values a company by looking at how the market prices similar businesses right now. It is faster than a DCF and grounded in real market prices, which is why it is one of the most widely used methods in practice, usually alongside a DCF rather than instead of it. It leans on the multiples you learned in Unit 2.
Introduction to comparable valuation (Corporate Finance Institute)
A short intro to relative, or comps, valuation. Watch how a peer multiple gets applied to a target company to imply a value.
The basic logic
The reasoning is simple. If similar companies in the same industry trade at a certain valuation multiple, then the company you are analyzing should, all else equal, trade at a similar multiple. You assemble a group of comparable public companies, observe the multiples at which they trade, and apply those multiples to your target company's financial metrics to imply a value. This is relative valuation: worth measured against the market's pricing of peers, rather than against intrinsic cash flows.
Key terms
- Comps
- Comparable company analysis. Valuing a company using the multiples of similar public companies.
- Peer group
- A set of genuinely comparable companies, similar in industry, size, growth, and risk.
- Relative valuation
- Valuing something against the market's pricing of peers, rather than its own cash flows.
- EV/EBITDA
- A common multiple: enterprise value divided by EBITDA. Often used in comps.
How it works in practice
- Select a peer group of genuinely comparable companies, similar in industry, size, growth, and risk.
- Calculate relevant valuation multiples for those peers, such as P/E, EV/EBITDA, or price-to-sales.
- Apply the typical peer multiple to the target company's matching metric. If peers trade at 15 times EBITDA and your target earns 100 of EBITDA, the implied enterprise value is about 1,500.
- Use a range of peer multiples to produce a valuation range rather than a single point.
Valuing a company with comps
You are valuing a company that earns 80 of EBITDA. Its closest public peers trade at about 12 times EBITDA. What enterprise value does that imply?
- Take the peer multiple. Comparable companies trade at roughly 12 times EBITDA.
- Apply it to the target's metric. Multiply the target's 80 of EBITDA by 12.
- Read the result. 80 times 12 is 960.
Why it matters: Comps answer a different question than a DCF. Instead of what the business is worth in theory, they ask what the market is paying for businesses like it today.
Apply a peer multiple
A company earns 50 of EBITDA. Its comparable peers trade at 14 times EBITDA. What is the implied enterprise value?
Comps answer a different question than a DCF: not what the business is worth in theory, but what the market is paying for businesses like it today.
The strengths
Comparable company analysis has real advantages. It is quick, it relies on observable market data rather than long chains of assumptions, and it reflects current market conditions. Because it is anchored in actual trading prices, it is a useful reality check on a DCF, which can drift far from market reality if its assumptions are off. When a DCF and a comps analysis broadly agree, you can hold your estimate with more confidence.
Comparable company analysis tutorial (Breaking Into Wall Street)
A fuller walkthrough of building a comps analysis end to end. Watch to see how a peer group is chosen and adjusted.
The weaknesses
The method carries a deep limitation you must always keep in mind. Comps assume the peer group is itself fairly valued. If an entire sector is caught in a bubble or a panic, comparable analysis will faithfully reproduce that mispricing, valuing your company richly in a bubble and cheaply in a crash. Truly comparable companies are also hard to find, since no two businesses are identical in growth, margins, and risk. And multiples are blunt, because they compress all of a company's differences into a single ratio, ignoring company-specific factors a DCF can capture. The lesson is that comps and DCF are complements. One grounds you in the market, the other in fundamentals. Used together, they are far stronger than either alone.
Comps in a bubble
An entire industry is in a speculative bubble, and every peer trades at 40 times earnings, far above normal. You value a company in that industry using comps. What will your comps valuation do?
Comps assume the peer group is fairly valued, so in a bubble they reproduce the inflated pricing. This is exactly why comps and a DCF are used together, so fundamentals can flag when the market has drifted.Why use both methods?
A DCF and a comps analysis answer different questions. In a couple of sentences, explain why an analyst gains confidence when the two methods point to a similar value, and what it means when they disagree sharply.
Write an answer before comparing it with the model response.
Model answer
A DCF values a company on its own fundamentals, while comps value it against what the market pays for peers. When both point to a similar value, two independent approaches are agreeing, which raises my confidence that the estimate is reasonable. When they disagree sharply, it is a signal to investigate, because either my DCF assumptions are off or the market is pricing the peer group unusually, and that disagreement is itself useful information.
Comps tell you what the market pays for similar companies trading on an exchange. The next lesson asks a related question with a twist: what have real buyers paid to acquire similar companies outright?