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Comparable Company Analysis

What is Comparable Company Analysis (CCA)?

Comparable Company Analysis (CCA) is a valuation technique employed to approximate a company's value using comparable publicly traded firms in the same industry or sector.

The theory is that comparable businesses ought to be valued similarly, provided that they enjoy similar risk, growth, and profitability profiles.

When is CCA Applied?

CCA is extensively applied in:

  • Investment banking for mergers, acquisitions, and IPOs
  • Equity research to determine target prices
  • Corporate finance to analyze performance or make strategic choices
  • Private equity for filtering out investment opportunities

How Comparable Company Analysis Works?

The simple steps of CCA are:

1. Select Peer Companies

Select firms that are comparable on the basis of:

  • Industry
  • Size
  • Business model
  • Geography
  • Financial profile (e.g., margins, growth rates)

2. Collect Financial Data

Collect financial metrics of the selected peer companies, including:

  • Revenue
  • EBITDA
  • Net income
  • Market capitalization
  • Enterprise value (EV)

3. Calculate Key Valuation Multiples

Common valuation ratios applied in CCA include:

  • EV/EBITDA (Enterprise Value to EBITDA)
  • P/E (Price-to-Earnings)
  • EV/Revenue
  • P/B (Price-to-Book)

4. Apply Multiples to the Target Company

Take the median or average multiple of the peer group and apply it to the target company's metric.

Example:
The average EV/EBITDA of peers is 10x and the EBITDA of the target company is ₹100 crore, then:

Implied Enterprise Value = 10 × ₹100 crore = ₹1,000 crore

Advantages of Comparable Company Analysis

  1. Market-Based: Based on real-time market data and reflecting current investor sentiment.
  2. Easy to Execute: Simpler and quicker than other valuation techniques such as DCF.
  3. Benchmarking Instrument: Facilitates comparison of a company's performance and valuation with peers.

Drawbacks of Comparable Company Analysis

  1. Identification of Truly Comparable Companies: Even comparable companies may have significant differences.
  2. Market Volatility: Valuations can be skewed during booms or busts.
  3. Short-Term Orientation: CCA is based on prevailing market conditions and can overlook long-term fundamentals.