Explore the complexities of valuation in the financial market through two main comparable valuation methods: Trading Comps and Transaction Comps. Learn how these valuation methods are applied in the industry and discover why valuation is considered an art as much as it is a science.
Key Insights
- The comparable model is a relative valuation approach used in the financial industry.
- Trading Comps is a comparable valuation method that focuses on market comparables for a firm and its peers within the same industry and of similar size.
- Transaction Comps, the second comparable approach, involves examining market transactions where similar firms or divisions have been acquired by other rivals, private equity firms, or other classes of large, deep-pocketed investors.
- Finding truly comparable companies and transactions for valuation can be challenging, making this the most difficult part of a comparables analysis.
- Using trailing and forward multiples can significantly impact analysis. For rapidly growing firms, historical valuations may not be overly accurate. Future market multiples are more crucial to valuation.
- Valuation is as much an art as it is a science. Instead of focusing on the exact dollar figure of equity, it is more practical to determine a valuation range.
DCF Workflow
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Forecast Free Cash Flows
5-10 years of FCF based on operating assumptions.
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Calculate Terminal Value
Gordon growth or exit multiple beyond projection.
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Discount at WACC
PV each year's FCF, sum to enterprise value.
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Adjust to Equity Value
Subtract net debt, divide by shares for per-share value.
The comparable model is a relative valuation approach.
2 main comparable valuation methods are:
Trading Comps: The first primary comparable approach is the most common and looks at market comparables for a firm and its peers: in the same industry and similar size companies.
Transaction Comps: The second comparable approach looks at market transactions where similar firms or divisions have been bought out or acquired by other rivals, private equity firms, or other classes of large, deep-pocketed investors.
It is important to note that it can be difficult to find truly comparable companies and transactions to value equity. This is the most challenging part of a comparables analysis.
Additionally, using trailing and forward multiples can make a big difference in analysis. If a firm is growing rapidly, a historical valuation will not be overly accurate. What matters most in valuation is making a reasonable estimate of future market multiples. If profits are projected to grow faster than rivals, the value should be higher.
The stock market can become overvalued at times, which would make a comparable approach less meaningful, especially if comps are overvalued. For this reason, using all different valuation approaches is the best idea.
Valuation is as much an art as it is a science. Instead of obsessing over what the true dollar figure of equity might be, it is most valuable to come down to a valuation range.
Video Transcription:
Full Video Transcript
Overview of the Comparables Approach
In this video we're going to talk about the comparables approach to equity evaluation. The comparable model is a relative valuation approach. Two main comparable methods are trading comps and transaction comparables.
The first primary comparable approach is the most common and looks at market comparables for a firm and its peers in the same industry and similar size companies. The second comparable approach looks at market transactions where similar firms or divisions have been bought out or acquired by other rivals, private equity firms, or other classes of large deep-pocketed investors. We will look into each comparable variation method in our following videos closely.
Challenges in Comparable Analysis
It is important to note that it can be difficult to find truly comparable companies and transactions to value an entity. This is the most challenging part of a comparables analysis. Additionally, using trailing and forward multiples can make a big difference in an analysis. If a company is growing rapidly, a historical valuation will not be overly accurate.
Key Considerations for Accurate Valuation
What matters most in valuation is making a reasonable estimate of future market multiples. If profits are projected to grow faster than rivals, the value should be higher. Also, the stock market can become overvalued at times, which would make a comparable approach less meaningful, especially if comps are overvalued.
For this reason, using different approaches to valuation is the best idea. Valuation is as much an art as it is a science. Instead of obsessing over what the true dollar figure of an equity might be, it is most valuable to come down to a range.
