Learn about the comparable company valuation method from the industry experts at Investment Business Brokers.
Comparable Company Valuation
What is a Comparable Company Valuation?
A comparable company analysis is a business valuation technique used to price a company by using criteria from other businesses of similar size in the same industry. The underlying assumption is that related companies will share similar valuation multiples. These multiples are gathered from a comprehensive list of businesses and averages are taken to determine a relative valuation.
Multiples that are Considered
There are many different multiples that can be considered for this business valuation methodology. Depending on company size and industry, analysts will look to use different multiples. For instance, smaller-sized businesses will use enterprise value/discretionary earnings which means the total price of the company divided by the profits it produces. Let’s look at an example.
A company is producing discretionary earnings of $1 million each year. Comparable companies in the industry are being sold with an enterprise value/discretionary earnings of 4x. Therefore, if we are trying to value our business, we would take the $1 million of earnings and multiply it by 4x. As a result, we would get a total enterprise value of $4 million.
Another common multiple used is the enterprise value/revenue multiple which means the total price of the business divided by the sales. We will look at this in example 2.
A company generates $10 million in sales each year. Comparable companies in that are similar in size and operate in the same industry are selling with an enterprise value/revenue multiple of 0.5. To calculate, we take the $10 million multiply it by the multiple of 0.5 to conclude a total enterprise value of $5 million.
It’s important for the analysts performing the comparable valuations to pull multiples from companies that will produce an accurate valuation. They do this usually by spending big dollars to use software platforms that provide current market data for public and private companies.
How to Evaluate Comparable Companies
The process to value comparable companies is fairly standard. It involves gathering the metrics required such as revenues and earnings for a business. Then, screening for comparable company data to capture the applied multiples.
Comparable Company Valuation Review
The comparable business company valuation method does not require an intense technical analysis and is relatively easy to perform. This valuation method should provide a reasonable valuation range, while other business valuation methods such as discounted cash flow valuation are dependent upon an entire array of assumptions.
Advantages of the Comparable Company Valuation
Easy to calculate: For public companies, it is fairly simple for anyone to do this valuation as the information about public companies is widely available. Private companies are slightly harder to value due to the lack of attainable data.
Widely Accepted: It’s hard to make the argument that this valuation is inaccurate. To quote the old saying “The market determines the price people are willing to pay”.
Disadvantages of the Comparable Company Valuation
Temporary Market Conditions: The financial markets move up and down in cycles based on economic indicators throughout time. If the economy is booming, you will most likely get more for your business and vice versa.
Dependent on Comps: If no applicable comparable companies exist in a given industry for a business, then it makes it harder to establish value.
Business Valuation: Investment Business Brokers Can Help
It is always in your best interest to consult an industry professional such as a valuation analyst, business broker or M&A advisor to ensure you know how to value your business accurately. If you need a business broker in Texas, Investment Business Brokers can help.
If you have any other questions about how a comparable company valuation works or want to know how much your business is worth, contact us contact us and we are happy to share our knowledge with you.
Call Investment Business Brokers at 972-266-4525 to learn more about our business brokerage services including business valuation services. We bring the experience of our best team to bear. Our local business brokers have over 25 years of experience in the industry.
Business Valuation Methods
To learn more about other business valuation methods, look at the links listed below. Additionally, browse the Investment Business Brokers blog for helpful insights.