in this video we'll go over the comparable company's valuation from learning the basic
theory to applying the concepts on excel and eventually reaching a valuation range for a
company and even though the name sounds very fancy this is actually a valuation method that
we use all the time as it's simply valuing an asset by comparing it to other similar assets
suppose we found a house that we like that costs 300 000 and it's got 2 000 square feet
but because this is our first house we're not really sure if it's worth the price
and so we look around the neighborhood to see if there's other houses that have been sold recently
in the process we find out the house in front was sold for 600 000 but it's bigger at 4 000 square
feet so it's not quite fair to compare the price difference as there's obviously a difference in
size as well instead we can use a ratio like the price per square foot and this way we can find
out that they're both actually selling for 150 per square foot based on this metric it seems
like the house that we want is actually selling at a fair price that's the basic idea with this
valuation method now that we have an understanding of this let's take a look at the key steps in a
comparable companies valuation also known as a multiples valuation firstly you need to identify
comparable companies the theory is that similar companies provide a good reference point to
value the company that you're targeting and i say companies here but this is really for any asset it
could be back to our housing example where you looked at neighboring houses to be able to tell
what your house is worth as well secondly we need to find the relevant numbers which will allow us
to calculate the multiples or the ratios for the housing example it was gathering the price
as well as the size to then be able to calculate the multiple which was the price per square foot
once we gather all the data we can benchmark these multiples so calculating the averages the medians
etc of all of the comparable companies and lastly we can determine the valuation range for the
company that we're interested in and don't worry if this wasn't all that clear we'll get into all
of these steps in detail so let's get into it step one is selecting the comparable companies and this
step is quite important if you don't select the right companies then your whole valuation is going
to be flawed there's really two types of things you need to consider here business and financial
when it comes to business it's making sure they're in the same industry that they operate in similar
market regions and they have a similar target customer after all it wouldn't be fair to compare
a luxury fashion brand like say dolce gabbana to a fast fashion brand like h m even though they're
both selling clothes right on the financial side it's about their numbers are they of similar sizes
it wouldn't be all that accurate to compare a startup with a thousand dollars in revenue
to a company that's mature and has 10 billion in revenue there's also profitability so seeing if
they have similar margins and the credit profile which is essentially how risky they're perceived
to be by investors with these points in mind how do we go about actually finding comparable
companies a simple and free way to go about it is looking at the company you're interested in
and looking at their annual report suppose we're looking to value nike just going to nike's annual
report there's a section called competitors in which you can see it's stating all of the
competitors that they have and what they do alternatively 4k options include bloomberg or
capital iq depending on where you work or study this might be available to you for free though
in my case for example when i signed up cornell these were available to us students this whole
process should end up with you finding about five to ten comparable companies the next step
is gathering the relevant data and calculating the multiples for this we first need to know what
multiples we'll be using and generally these are split into enterprise value multiples or equity
value multiples the enterprise value ones here are in dark blue while the equity value ones are in
the lighter blue the difference is that enterprise value refers to the entire business of both debt
and equity holders while equity value is only referring to the equity holders when looking
at the multiples ebitda and revenue both flow to debt and equity holders while earnings is
only for equity holders as its net of interest expense unfortunately these multiples aren't
always applicable for example if a company has no earnings or very little earnings you probably
can't use a price to earnings ratio similarly you might not even be able to have ebitda in there
and so in that kind of a scenario probably your ev over revenue is going to be your best resource
these are some of the more popular ratios but there's also some industry specific ones like ev
over subscribers for a media company like netflix or ev over square footage for a real estate firm
once we know the metrics that we want we can go ahead and start gathering the data that can either
be done in a company's annual report in bloomberg in cup iq etc to apply this theory let's suppose
that we're a lemonade business called enjoy lemon over here and we're trying to assess our values so
how much we're worth and for that we've gathered these comparable companies which are some of our
competitors and we've got their different sets of data that we're gonna need to then be able to
calculate the three different multiples that we've got over here to calculate these multiples we're
gonna need both the enterprise value as well as the equity value so let's go ahead and find out
how to calculate them for the equity value it's just gonna be the share price times the shares
outstanding press enter there and from there you can just drag it down by just going ctrl c
then we'll go alt h v f that's just going to paste the formulas for us press the f2 key if
you want to verify that then for the enterprise value that's going to be the equity value plus
the net debt which is just that minus cash so go equals equity value plus the net debt over here
and again just drag that down onto hvf nice now we can go ahead and start calculating these as
we have the relevant data so for the ev over revenue it's just gonna be the enterprise value
let's make sure to lock that one so we can move it across so press the f4 key three times there
such that the dollar sign is only on the age then we're gonna divide that by the revenue over here
and press enter then we can just drag that across so we'll just select it and then we'll go to
alt hvf and there you go so we have it both for the revenue as well as for the ebitda for the
pe this is going to be slightly different as this is the equity value and not the enterprise value
so for this one it's going to be equals to the equity value divided by the net income which is
essentially the same thing as the price per share over the earnings per share presenter
then we're just going to drag that down then alt h we have nice that's the end of the second step
and speaking of valuation if you're liking this video you can also check out our complete finance
evaluation course where an investment marker a financial analyst and myself
teach everything we know about finance valuation and financial modelling
first we start with the basics of financial accounting and ratio analysis where we learn
to analyze a company's financial health using apple's real annual report as an example once
we're comfortable with the content we start with financial modeling through a three statement model
then we begin the valuation phase with the discounted cash flow method starting with the
theory of the time value of money all the way to calculating the weighted average cost of capital
after the theory we'll apply our learnings by creating a full discounted cash flow on adobe
looking at their real financial statements to eventually derive a valuation range and
an implied share price alongside the discounted cash flow we'll learn two more common valuation
methods in the comparables company's valuation as well as the present transactions valuation
once we have all the valuation ranges we'll create visuals to showcase our findings
and learn how we can present our investment pieces in a stock pitch format
so if you're interested we'll be running big discounts for the first week since this video
is published so go ahead and check that out in the link in the description alright back to the video
now the third step is to benchmark the multiples because each lemonade company is going to
be slightly different we want to try to find something like an average or a median to be able
to assess how much our company should be worth based on what multiple so let's go ahead and do
that we're going to get the highest the quartiles the average and the medians all the way to the
minimums so for the height that's just going to be the max function versus the top key let's go ahead
and select these press enter 75th percentile for that we can use the quartile function
press the tab key the array is going to be this one comma and over here we want to find the the
third quartile which is the 75th percentile so put a three there press enter the average is
just the average function then we'll select these then the median is just the median function there
press enter for a 25th percentile it's also equals to the quartile function and from there
we'll select this range over here press the comma key and we want to find the 25th so put a 1 there
press enter and lastly for the low it's just the minimum press the top key and we'll select
this range over here from there we can just go ahead and select this and drag it across
as you can see here both the average as well as the median are the ones in bold because they're
usually the most relevant ones um typically you might want to prefer using the medium if there's a
lot of outliers which the average accounts for so for example let's say that this lemonco over here
had say a hundred hundred times ev over revenue then as you can see the average would be distorted
but the median would actually stay the same so that's why sometimes you might prefer to
use the median let's now work on the final step which is determining evaluation range
and for this we'll be down over here where we want to find out the enjoy lemon valuation
starting off with the implied enterprise value for the ev over revenue that's just going to be equals
to we can select either the average or the median over here let's say we go for the median then we
multiply that by the revenue which is going to be this figure over here for enjoy lemon press
enter once we have the implied enterprise value we already have the net debt which is going to be
this figure up over here then make sure to lock you press the f4 key once and press enter
so the implied market value is just going to be equals to the implied enterprise value
minus any debt that they have and then press enter lastly there for the shares outstanding that's
going to be equals to the shares outstanding that they've got over here so that's 125
and then the implied value per share is just going to be equals to the implied market value divided
by the shares outstanding so that gives us 9.61 from there we can go ahead and drag this over so
we'll go ahead and select it and just drag it over here if we've locked everything correctly
which i think we haven't because we forgot to lock the shares out sounding press the f4 key
there then just copy and paste that now we've got for the ev over ebitda we've got a
share price or an implied share price of 13.05 then lastly here we've got the pe ratio which
is going to be slightly different because this is an equity multiple and not a enterprise value one
so it's actually going to get us the implied market value for that we'll go to equals we'll
select the median and then multiply that by the net income over here for enjoy lemon press enter
we can get the shares outstanding just copying it from across and that should give us the share
price which is going to be 9.77 if you want to go ahead and also want the implied enterprise value
you can go reverse that calculation so we will actually copy the net debt that we've got equals
this one plus the market value that should give us the enterprise value as well so here we could
conclude with something like hey the implied value per share for enjoy lemon is around say 9 to 13
which seems to be in line with the current share price of 11.4 one thing to note is that the
comparable companies valuation is not a perfect method on the pro side it is very simple to use
and it doesn't take too much time definitely a lot easier than something like a discounted cash flow
that being said on the coin side it's easily influenced by the market which can also be a
pro sometimes so for instance say if the entire market is overvalued then obviously your company
is going to be overvalued as well because it's based on industry peers another con especially
for big companies is that it's not very easy to find comparables for example if for a company of
the size of apple with all of their offerings it's not that simple to find another competing
company there for these reasons it's quite common to use more than one method to value a company
for example similar to the comparable companies is precedent transactions which is also market
based but on how much was paid for a similar transaction in the past then there's discounted
cash flow also known as dcf which looks internally at the company's future cash flows
to estimate value now in order to keep this video concise we actually had to make a few
simplifications so let's look over them for the shares data which we found on the excel file as
these shares outstanding over here usually it's not all that simple to find this there's other
types of shares that we need to account for like stock options convertible bonds and other things
like that that are going to change the number of shares outstanding then there's calendarization
and not all companies finish the fiscal year at the same time in our case we didn't really
consider the dates but generally speaking maybe a company finishes their fiscal year
say in may while another one finishes it in september and so there's gonna be a discrepancy
in the time period that you're comparing which you'll need to adjust for lastly going from
enterprise value to equity value usually has a few more line items than just net debt these sometimes
include preferred stock minority interest etc now those are not all the simplifications there's
other ones but we don't want to make this video too long let me know down in the comments if you
want a video on comparable companies for a real company for more evaluation you can check out this
link over here for our course this other video over here for the discounted cash flow method
or this video over here to look at valuation methods more generally that's all for this
video hit that like hit that subscribe if you liked it and i'll catch you in the next one