Comparable Valuation Analysis

Course Instructor

About Jeff...
Prior to joining CFI, for over a decade Jeff taught
financial modeling and valuation to thousands of
students all over the world. Before his career in
financial education, Jeff covered approximately 50
companies with a combined market cap of $500
billion during his career in equity research. He also
worked in corporate development leading M&A
modeling and due diligence, and FP&A, as well as
working in investment banking and restructuring.
Jeff has a B.S. from Texas A&M University and
obtained his MBA from the University of Houston.
He is a CFA charterholder.
Jeff Schmidt

VP, Financial Modeling

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Learning Objectives

Understand relative valuation versus Recognize the advantages and Determine how to pick comparable
other valuation methodologies. disadvantages of relative valuation. companies and precedent transactions.

Match enterprise value and equity value Identify debt and debt equivalents as Find and enter the applicable data using
with appropriate metrics. well as cash and other non-operating real-world examples.
assets.

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Introduction to Comparable Valuation Analysis
Valuation
Valuation is the art and science of attributing a value to an investment.

Examples of investments: Company stock, assets, prospective projects, real estate.

Valuation does not equal price. A public company’s stock price may not be
properly valued by the market, hence why we go through the valuation process.

“Price is what you pay, value is what you get.” – Warren Buffet (2008 Berkshire Hathaway shareholder letter)

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Why Value Companies or Assets
Valuation is probably the most crucial aspect of finance and is used in the processes below:

Investment Corporate Certain Accounting

Purposes Actions Policies
Buy, Sell or Hold a Purchase a Acquisition
stock; Invest in a company; Accounting; Mark-to-
company project Sell a division Market Accounting

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Valuation Techniques

Valuing a Business or
Asset

Asset Approach Income Approach Market Approach

(FMV of Net Assets) (Intrinsic Value) (Relative Value)

• Cost to build • Discount Free Cash • Public Company

• Replacement Cost Flows (DCF) Comparables
• Residual Income • Precedent
(Economic Value Transactions
Added)
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Market Approach
Why is the market approach also called relative valuation?

The ultimate valuation is based relative to other, similar assets.

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Types of Relative Valuation

Public Company Comparables

Valuation based on the idea that similar Due to size differences, we scale similar
public companies share similar risk companies by using a ratio or multiple.
and reward characteristics, and
therefore should trade similarly. The multiple is usually based on a
financial metric (e.g. Revenue, EBITDA,
Earnings Per Share (EPS)).

Precedent Transactions Sometimes the multiple is based on a

Valuation based on the acquisition of capacity factor (e.g. Oil or Mining
companies similar to the target Reserves).
company.

Key difference is that precedent transactions usually result in higher

multiples due to the presence of the 'control premium' in an acquisition.
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Advantages and Disadvantages of Relative Valuation
Let’s discuss some advantages and disadvantages of relative valuation.

Advantages Disadvantages

Calculating and applying multiples is a relatively

While simplicity is an advantage, relative
simple and user-friendly way of valuing a
valuation can also be too simplistic.
company, as well as communicating that value.

Avoids the potentially misleading precision of No two companies, or transactions, are

other, more ‘precise’ valuation methodologies exactly alike making the valuation more
like DCF, so it’s harder to manipulate. difficult.

Market data is directly observable. We can Even if you find good peer companies or
directly observe a public company’s market transactions, sometimes information can be
capitalization. hard to find or out-of-date.

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Valuation Example
One of the best and most intuitive ways to conceptualize relative valuation is by looking at the value of house sales.

We need to look for a common denominator

that neutralizes size discrepancies…

Price
We scale for differences in
Sq / ft size.

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Price Per Square Foot

Comparable Comparable Comparable Homeowner’s

House 1 House 2 House 3 House
Sales price: 352,000 Sales price: 494,000 Sales price: 346,000 Sales price: ??
Square Feet: 2,500 Square feet: 3,000 Square feet: 2,250 Square feet: 3,500

Price 352,000 494,000 346,000

Sq / ft = 2,500 = 3,000 = 2,250

= 140.80 / Sq Ft = 164.67 / Sq Ft = 153.78 / Sq Ft

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Valuation Example Continued
1. Find the average price / sq ft from the comparable houses.

2. Multiply the average price / sq ft by the house’s sq ft.

Sales
Price (USD) Sq Feet Price / Sq Ft
Comparable House 1 352,000 2,500 140.80
Comparable House 2 494,000 3,000 164.67
Homeowner’s
Comparable House 3 346,000 2,250 153.78
House
AVERAGE 153.08
Square ft: 3,500

153.08 * 3,500 = 535,785

While this is technically an example of a precedent transaction valuation, this basic methodology also works
for publicly traded companies.

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Putting It All Together
Comparable Trading Analysis

All figures in USD millions unless stated

Enterprise EBITDA EV / EBITDA

The same methodology applies to companies. Peer Companies Value LTM 1 LTM 1

Company 1 10,142 586 17.3x

In this example, we scale different companies’ Company 2 10,846 569 19.1x
enterprise value by EBITDA. Company 3 11,584 530 21.9x
Company 4 12,787 542 23.6x
Company 5 12,328 525 23.5x
From there, we calculate the average, median, Company 6 10,500 516 20.3x
maximum and minimum enterprise value to EBITDA
multiples. 2
Target Company Valuation

Average 10,178 486 20.9x

We then apply these multiples to the target Median 10,256 486 21.1x
company’s EBITDA to calculate the target’s enterprise Maximum 11,466 486 23.6x
Minimum 8,411 486 17.3x
value.

LTM means Last Twelve Months. ⁽¹⁾

Target Company Valuation based on LTM Multiple. ⁽²⁾

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Screening for Comps
Screening for Comparables
In order to learn about the target company, read as much about it as possible, including sector-specific material.

Annual & Quarterly Equity & Credit Investor Earnings Conference

Reports Research Presentations Transcripts

Pay special attention to the conference call Q&A as that

gives you a better idea of what concerns or opportunities
research analysts focus on.

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Steps in Performing a Comparable Trading Analysis
Once we understand the target’s business, we can go through a comparable company analysis, which consists of 3
steps.

Locate and enter the Value the ‘target’

Select appropriate
Select Locate relevant information Value company using the
peer companies.
into a comps model. selected multiples.

This is the most important We will cover this in later

part of comps modeling. lessons!

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Selecting Appropriate Peer Companies
Realistically, this is the most important part of comps modeling and where you should spend the
bulk of your time.

Similar Risks Factors No Peers? Closest Comps

You want to identify If there are no peers, The valuation should

firms with similar risk you can look outside be determined based
factors as the ‘target’ of the target firm’s on the closest comps.
firm. sector.

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Business and Finance Characteristics
There are two categories of key characteristics.

Business Characteristics Finance Characteristics

Industry/Sector (Sub-sector) Size

Geography Growth
Products/Services Margins
Customers Seasonality/Cyclicality
Distribution network Leverage/Credit rating

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Why Perform a Precedent Transaction Analysis
Let’s talk about the other relative valuation technique: precedent transactions.

Why perform a precedent transactions analysis?

To determine a hypothetical To compare against other

sales price for a company. valuation methodologies
(e.g. Trading Comps,
Discounted Cash Flow (DCF))

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Selecting Appropriate Transactions
Just like trading comps analysis, there are three main steps in performing a precedent transactions analysis:

Locate and enter the Value the ’target’

Select appropriate
Select Locate relevant information Value company using the
transactions.
into a comps model. selected multiples.

Financial or Strategic,
Offer/Transaction
Value, Consensus
estimates, Control
Premium, Synergies, etc

Most important part of Some financial details

Comps modeling and time are typically only
consuming. provided when material.
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Recent Deals and Fairness Opinions
The process is essentially the same as trading comparables as we focus on the same business and
financial characteristics.

Recent Deals
Try not to use older transactions as industries and market conditions
change. However, older deals may be necessary in order to create a
more robust valuation.

Fairness Opinions
A good source for recent transactions is by looking at fairness opinions.
These are documents put together by investment bankers
highlighting recent transactions to advise shareholders.

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Business and Finance Characteristics
In a transaction, the terminology changes.

Offer Value Transaction Value

When we refer to offer value, we are referring When we refer to transaction value, we are
to the purchase of the target company’s referring to the offer value plus net debt (so
equity. roughly analogous to enterprise value).

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Football Field Chart
Value cannot be directly observed. That’s why we use multiple different valuation approaches to ‘triangulate’ what
we think the value of a company should be.
15,000 14,569

14,000

12,848
13,000

12,000
11,466
11,673
11,000

10,000

9,000
Typically returns the highest
8,000 8,411 valuation because of the
7,000
control premium.
6,850
6,000
Comparable Trading
Trading Analysis
Analysis Precedent Transaction Analysis DCF Valuation Analysis

Comparable Trading and Precedent Transaction Analysis both use LTM EBITDA.
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Enterprise Value vs. Equity Value
Balance Sheet Equation
Let’s look at the balance sheet equation: Assets equals Liabilities plus Equity.

Assets Liabilities Equity

Operating Assets Operating Liabilities Equity

(e.g. Inventory, PP&E) (e.g. Accounts Payable, (e.g. Common Shareholder
Deferred Revenue) Equity)

Non-Operating Assets Financial Liabilities

(e.g. Cash, Securities) (e.g. Interest-Bearing
Liabilities, Debt)

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What is Enterprise Value?
Enterprise value is the total value of a company’s operations.

Operating Non-Operating Operating Financial Shareholder

Assets Assets Liabilities Liabilities Equity

Operating Operating Financial Non-Operating Shareholder

Assets Liabilities Liabilities Assets Equity

Market
Enterprise Value Debt Cash
Cap/Equity

We generally do not use balance sheet numbers when calculating enterprise value; however, we can
use the balance sheet equation to show that Enterprise Value is the value of a company’s operations.

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Enterprise Value and Equity Value
Next, the other measure of a company’s size is its equity value or market cap.

While enterprise value is the value of a company’s operations, equity value is the residual value of the business,
after all claims on that business have been paid.

We can directly calculate market cap by taking the public company’s share price times the number of shares
outstanding.

Enterprise Value Debt Cash Equity

Net Debt

Equity
Enterprise Value Net Debt Market Cap
Value

If there is a significant difference between the equity value and

market cap, then that could result in a profitable trading strategy.
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Enterprise Value: Debt and Debt Equivalents
List of Debt and Debt Equivalents

Debt

Long-term Current Portion of Revolving Commercial

Debt Long-term Debt Line of Credit Paper

Debt Equivalents

Leases Noncontrolling Preferred

Interest Stock

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Traditional Debt
Debt is interest-bearing and generally has a higher ‘claim’ on a company’s business than any other source of
funding.

This is important because debt gets paid first before other funding sources.

Debt may have different names and come in different structures:

Long-term Debt Revolving Line of Credit

(including Current Portion of Long-term Debt) (Revolver)

Commercial Paper Notes, Bonds, Loans, Borrowings

(Unsecured money-market instrument sold at a discount
to face value; usually repaid within a year)

Convertible debt may even be convertible into common equity.

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Finance and Operating Leases
Debt Equivalents = Leases

Nearly all leases, whether classified as a finance or operating lease, are recognized on the balance sheet.

Balance Sheet

Liabilities Lease liability

Right-of-use asset Assets

Equity

One way to think of a lease is a company purchasing a piece of property or

equipment by issuing debt. Leases have an implicit interest rate embedded in the
lease terms so we should consider leasing a form of collateralized borrowing.

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Finance and Operating Leases
There is a key difference between how US GAAP accounts for operating leases versus IFRS:

US
IFRS
GAAP

Interest
Expense
Any lease
cost
Depreciation
Expense

A lease is essentially a collateralized

borrowing so this treatment should make sense.

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Finance and Operating Leases
There is a key difference between how US GAAP accounts for operating leases versus IFRS:

US
IFRS
GAAP

Interest
Expense
Finance Operating Leases
Leases
Depreciation
Expense
Expressed as rent

This presents some comparability issues between IFRS and GAAP. EBITDA
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Finance and Operating Leases
If we want to compare an IFRS company with an US GAAP company, we need to add back the US GAAP company’s
rent expense.

US
IFRS
GAAP

Results in numerator and denominator

Operating Leases
consistency since leases will be a debt EBITDA + R
Expensed as Rent
equivalent in the numerator of enterprise value.

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Preferred Stock
Preferred stock is essentially a hybrid debt and equity security.

It has a higher claim than common shareholders on the company, and preference on dividends.

IFRF & US GAAP

Balance Sheet

Liabilities
Valuation Purposes
Assets
Common Stock Preferred stock should still be
Equity Preferred Stock considered a debt equivalent
Retained Earnings for valuation purposes and
included in net debt.

(Net debt = Debt – Cash)

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Noncontrolling Interest (NCI)
Although noncontrolling interest (NCI) typically shows up in shareholder’s equity on a balance sheet, it is not
considered common equity and should be included in net debt as a debt equivalent.

Parent

30%
80%
Subsidiary B
Subsidiary A
Equity
Consolidate
Method

EV 80% of Subsidiary A reflected We need to think of how much of the

= subsidiary is reflected in the numerator
EBITDA 100% of Subsidiary A reflected
and denominator of the parent.

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Nuances of Debt and Debt Equivalents
We want to use market values for all debt and debt equivalents, but that is not always the case.

Sometimes, we favor the book value since that is the

actual contractual amount the company must pay to
settle the debt.
Market Values

Usually, we do not have enough information to

estimate the market value of something like
noncontrolling interest (NCI), so we use book value
instead.

An alternative would be to apply a price-to-book

multiple to NCI to proxy the market value, but this
Book Values would require doing a separate comps analysis with less
information.

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Enterprise Value: Cash and Non-operating Assets
List of Cash and Non-Operating Assets

Cash & Cash Marketable or Assets Held for Investments in

Equivalents Liquid Assets Sale Unconsolidated Affiliates

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Investments in Unconsolidated Affiliates
An investment in an unconsolidated affiliate occurs when a company has significant influence over another
company (affiliate) but does not control it (between 20%-50% ownership).

Parent

30%
80%
Subsidiary B
Subsidiary A
Equity
Consolidate
Method

The company is entitled to a proportionate

EV 30% of Subsidiary A reflected
share of the affiliate’s income, usually =
EBITDA 0% of Subsidiary A reflected
below EBIT or operating income.

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Income Statement and Last Twelve Months (LTM)
Income Statement Data
Now that we have determined the company’s size (enterprise value and equity value), we need to work out the
appropriate financial metrics to calculate multiples.

We will focus on Enterprise Value to EBITDA and Share Price

to Earnings per Share (PE ratio).

We can easily calculate the enterprise value today, as well as

obtain the current share price.

However, we will need to calculate profitability metrics on a

historic or forward basis (using analyst estimates).

We will start by calculating historical profitability for the

last twelve months (LTM).

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Last Twelve Months (LTM)
There are a couple of different ways we can calculate an LTM.

Let’s adjust reported data to the last twelve months assuming the date is July 12, 2023.

Q1
Jan - Mar YTD Latest Fiscal Year EBITDA:
Q2 2022 $8,471
FYE Dec Apr - Jun
Latest Fiscal Year EBITDA:
$18,283 31, 2022 Q3
Jul - Sep

Q4
Oct - Dec

Q1
LTM EBITDA: Jan - Mar
YTD Current Year-to-date (YTD) EBITDA:
18,283 + 8,591 – 8,471 = $18,403 2023
Q2 $8,591
Apr - Jun

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Normalization and Analyst Estimates
Normalization
After entering the income statement data and calculating LTM metrics, we need to normalize these numbers.

What do we mean by normalizing?

Remove any
non-recurring
or unusual
gains or losses
the company
reports.

In effect, we want to determine what we think the core, ongoing profitability of the company should be, excluding
these one-off items.
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Typical Non-Recurring/Normalization Adjustments

Restructuring Foreign Exchange Gain/Loss on Sale of Stock-based Acquisition Integration

Adjustments Assets Compensation Expenses

Asset/Goodwill Impairment Reversal Amortization of Litigation

Impairments (IFRS only) Intangible Assets Gains/Expense

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Forward Estimates

When research analysts make projections (whether it’s EBITDA

or earnings per share or another metric), they use normalized
numbers.

So, we build the comps template to have research estimates in

the same area as the normalized numbers.

That way we are comparing like-for-like.

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Unlevered vs. Levered Metrics
Before we move on, we need to define the appropriate financial metrics to be used for multiples. We can categorize an
income statement into 2 different types of metrics.

Unlevered

Any financial metric before

interest expense. Levered
For example, earnings before
Any financial metric after
interest and taxes, or EBIT.
interest expense.

For example, net income.

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Normalization

Income Statement
Revenues
Less: Cost of sales
= Gross profit Unlevered Metrics
Less: Selling, general & administrative (Enterprise Value
= Earnings before interest, taxes, depreciation & amortization (EBITDA) Multiples)
Less: Depreciation & amortization
= Earnings before interest, taxes (EBIT)
Less: Interest expense
= Earnings before taxes (EBT)
Levered Metrics
Less: Income taxes
(Equity Value
= Net income
Multiples)
÷ Shares outstanding
= Earnings per share (EPS)

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Finding Normalization Adjustments and Entering Analyst Estimates

Before we get back into Excel, we need to find the company’s suggested
normalizations.

In the case of our comps, we can find the normalization adjustments on the income
statement, but this will not always be the case.

After normalizing several metrics, we will then enter the analyst estimates we
obtained from Capital IQ and calculate enterprise value and equity value multiples.

Let’s get started!

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Fully Diluted Shares Outstanding
Fully Diluted Shares Outstanding (FDSO)
We need to properly calculate a company’s true market cap. Therefore, we need to discuss the number of shares a
company has or may have.

Analysts prefer fully diluted shares outstanding

as this captures all potential shares.

The fully diluted share count is the basic share

Basic Shares Fully Diluted Shares count plus any potentially dilutive securities.
Outstanding Outstanding
Potentially dilutive shares come from:
- Employee stock options
- Warrants
- Restricted stock or other share awards
- Convertible debt or convertible preferred
stock.

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Stock Option Basics
In many companies, employees are given stock options to help incentivize them.

These stock options have a strike price

(exercise price) that the employee pays to
receive the number of shares in the options
agreement.
In-the-money options (ITM):
Exercise Price < Current Market Price
$5.00 < $5.50
An employee would only exercise the option if
the exercise price is less than the
company’s market price.
Out-of-the-money options (OTM):
Exercise Price > Current Market Price
$5.00 > $4.50

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Fully Diluted Shares Outstanding (FDSO) – Options and Warrants
When calculating the number of options to include in the fully diluted share count, we typically use a calculation known
as the treasury stock method.

The treasury stock method assumes that any proceeds the company receives from the employee will be used to
repurchase shares at the current market price.

Net Impact of Dilution = ITM Options – Shares Repurchased by Company

Technically, we should also include any unrecognized compensation cost as

proceeds but we don’t typically have enough information to do so.

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Fully Diluted Shares Outstanding – Restricted Stock
We also use the treasury stock method to calculate the dilution from restricted stock awards and/or restricted stock
units.

Net Dilution from Restricted Stock:

Hypothetical Proceeds = Unrecognized compensation costs related to RSAs/RSUs

Given the lack of information, we typically just add unvested restricted stock or other
stock awards directly to the basic share count to derive the diluted share count.

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Trading Comps Summary
Final Steps: Comparable Companies

After completing our first comp, we link our Summary table

to the appropriate metrics.

We then repeat the process for all our comparable

companies (use Excel’s find and replace to expedite this task).

We then add in the target company metrics and calculate

the implied valuations.

We will use a football field chart for the final output.

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Precedent Transaction Nuances
Precedent Transactions: Additional Details Needed
While the process behind selecting precedent transactions vs. public company comps is similar, there are several
additional data points and calculations we need to consider.

Deal Deal Target Acquirer

Announcement Date Status Share Price Share Price

(e.g., Announced,
Pending, Closed,
Withdrawn)

Merger consideration can come in either stock, cash or a combination of cash and stock.

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Merger Consideration

All-Cash Offer All-Stock Offer Mixed Offer

• The acquirer makes a cash offer for all the target’s outstanding shares,
assuming the target is a public company.

Total Consideration = Per-Share Amount * Target's Share Count

• If the target is private, the all-cash offer will be a lump-sum amount.

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Merger Consideration

All-Cash Offer All-Stock Offer Mixed Offer

• If the acquirer and the target company are both public, the acquirer will usually use an
‘exchange ratio’.

Acquirer Shares to be Issued: Number of Target Shares to be Acquired

• While there are different ways to structure an exchange ratio (fixed, floating, collared), we
will assume it is a fixed exchange rate.

Exchange Ratio * Acquirer’s Share Price = Target Share Amount

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Merger Consideration

All-Cash Offer All-Stock Offer Mixed Offer

• The Mixed Offer accounts for both the cash consideration and the stock
consideration.

• Our analysis will be set up to handle all 3 structures.

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Premium Paid Analysis
An acquisition premium is a figure that's the difference between the target’s market price and the actual price
paid to acquire it.

• If the target is public, we also want to know what the

premium paid might be.

• A premium is paid in order to acquire control of the target.

• If no premium was offered, selling shareholders would have

no incentive to sell.

• This premium is expected by both the acquirer and target.

• It is a common measure in mergers, acquisitions and

precedent transactions.

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Transaction Timing: 2021 Acquisition of Morrison’s PLC
With precedent transactions, we need to be aware of timelines.

The transaction won’t close for some time after the

announcement and signing of the merger documents.

An analyst must make a judgment call on what information

to use based on timing.

We are going to use the data available when the auction was
held when we calculate the offer value and transaction value.

For the premiums paid analysis, we are going to use the dates
when the original offer was made and the final, winning offer.

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Transaction Timing: 2021 Acquisition of Morrison’s PLC

June 14 July 3 October 2

First Offer Another Bid* Auction

June 21 August 19 October 4

First Offer Original bidder Original Bidder
Rejected raises bid price Wins Auction

* The other bid price was subsequently raised on August 6.

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Learning Objectives

Understand relative valuation versus Recognize the advantages and Determine how to pick comparable
other valuation methodologies. disadvantages of relative valuation. companies and precedent transactions.

Match enterprise value and equity value Identify debt and debt equivalents as Find and enter the applicable data using
with appropriate metrics. well as cash and other non-operating real-world examples.
assets.

Corporate Finance Institute®