Comparable Companies Analysis

Question 1

Five Steps of Comparable Companies Analysis

Answer 1

Select the Universe of Comparable Companies, Locate the Necessary Financial Information, Spread Key Statistics, Benchmark the Comparable Companies, Determine Valuation

Question 2

Select the Universe of Comparable Companies

Answer 2

The foundation for performing trading comps. It can prove challenging for companies whose peers are not readily apparent. To identify companies with similar business and financial characteristics, it is first necessary to gain a sound understanding of the target. As a starting point, the banker typically consults with peers or senior colleagues to see if a relevant set of comparable companies already exists internally. If beginning from scratch, the banker casts a broad net to review as many potential comparable companies as possible. This broader group is eventually narrowed, and then typically further refined to a subset of ‘closest comparables’. A survey of the target’s public competitors is generally a good place to start identifying potential comparable companies.

Question 3

Locate the Necessary Financial Information

Answer 3

Once the initial comparables universe is determined, the banker locates the financial information necessary to analyze the selected comparable companies and calculate key financial statistics. The primary data for calculating these metrics is compiled from various sources, including a company’s SEC filings, consensus research estimates, equity research reports, and press releases.

Question 4

Spread Key Statistics

Answer 4

This involves calculating market valuation measures, such as enterprise value and equity value, as well as key income statement items, such as EBITDA and net income. A variety of ratios and other metrics measuring profitability, growth, returns, and credit strength are also calculated at this stage. Selected financial statistics are then used to calculate trading multiples for the comparables. As part of this process, the banker needs to employ various financial concepts and techniques, including the calculation of LTM financial statistics, calendarization of company financials, and adjustments for non-recurring items.

Question 5

Benchmark the Comparable Companies

Answer 5

The next level of analysis requires an in-depth examination of the comparable companies in order to determine the target’s relative ranking and closest comparables. To assist in this task, the banker typically lays out the calculated financial statistics and ratios for the comparable companies alongside those of the target in spreadsheet form for easy comparison. This exercise is known as ‘benchmarking’. Benchmarking serves to determine the relative strength of the comparable companies versus one another and the target. The similarities and discrepancies in size, growth rates, margins, and leverage, for example, among the comparables and the target are closely examined. Certain outliers can be eliminated and/or the comparables can be further tiered.

Question 6

Determine Valuation

Answer 6

The trading multiples of the comparable companies serve as the basis for deriving a valuation range for the target. The banker typically begins by using the means and medians for the relevant trading multiples as the basis for extrapolating an initial range. The high and low multiples for the comparables universe provide further guidance in terms of a potential ceiling or floor. The key to arriving at the tightest, most appropriate range, however, is to rely upon the multiples of the closest comparables as guideposts. Consequently, only a few carefully selected companies may serve as the ultimate basis for valuation, with the broader group serving as additional reference points. The chosen range is then applied to the target’s relevant financial statistics to produce an implied valuation range.

Question 7

Factors to Determine ‘Universe’ of CCs

Answer 7

Business profile, sector, products and services, customers, end markets, distribution channels, geography, financial profile, size, profitability, growth profile, return on investment, credit profile.

Question 8

Income Statement Data

Answer 8

Sales, Gross Profit, EBITDA, EBIT, Net Income / EPS

Question 9

Balance Sheet Data

Answer 9

Cash balance, Debt balance, Shareholder’s Equity

Question 10

Cash Flow Statement Data

Answer 10

Depreciation & Amortization, Capital Expenditures

Question 11

Share Data

Answer 11

Basic Shares Outstanding, Options and Warrants Data

Question 12

Market Data

Answer 12

Share Price Data, Credit Ratings

Question 13

General Information Should Include

Answer 13

Company Name, Ticker, Stock Exchange, Fiscal Year Ending, Moody’s Corporate Rating, S&P Corporate Rating, Predicted Beta, Marginal Tax Rate.

Question 14

Sales

Answer 14

All else being equal, companies with greater sales volumes tend to benefit from scale, market share, purchasing power, and lower risk profile, and are often rewarded by the market with a premium valuation relative to smaller peers.

Question 15

Gross Profit

Answer 15

Sales - COGS, the profit earned by a company after subtracting costs directly related to production of its products and services. As such, it is a key indicator of operation efficiency and pricing power.

Question 16

EBITDA

Answer 16

Earnings before interest, taxes, depreciation, and amortization. Calculated by taking EBIT (or operating income) and adding back the depreciation and amortization. Used as a proxy for operating cash flow. In addition, serves as a fair means of comparison among companies in the same sector because it is free from differences in capital structure and taxes.

Question 17

EBIT

Answer 17

Earnings before interest and taxes. Often reported as operating income or income from operations. Less indicative as a measure of operating cash flow than EBITDA because it includes non-cash D&A expense. Furthermore, D&A reflects discrepancies among different companies in capital spending and/or depreciation policy, as well as acquisition histories (amortization).

Question 18

Net Income

Answer 18

‘The Bottom Line’, the residual profit after all of a company’s expenses have been netted out. Earnings available to the equity holders.

Question 19

Gross profit margin

Answer 19

The percentage of sales remaining after subtracting COGS. Driven by a company’s direct cost per unit, such as materials, manufacturing, and direct labor involved in production. Typically largely variable. Companies seek to increase their gross margin through a combination of improved sourcing of raw materials and enhanced pricing power, as well as by improving the efficiency of manufacturing facilities and processes.

Question 20

Net income margin

Answer 20

Measures a company’s overall profitability as opposed to its operating profitability. It is net of interest expense and, therefore, affected by capital structure. It is impacted by taxes as well.

Question 21

Return on Invested Capital (ROIC)

Answer 21

Measures the return generated by all capital provided to a company. As such, ROIC utilizes a pre-interest earnings statistic in the numerator such as EBIT or tax-effected EBIT and a metric that captures both debt and equity in the denominator. For example: EBIT / (Average Net Debt + Equity)

Question 22

Return on Equity (ROE)

Answer 22

Net income / Average Shareholders’ Equity

Question 23

Return on Assets (ROA)

Answer 23

Net income / Average Total Assets

Question 24

Dividend Yield

Answer 24

(Most Recent Quarterly Dividend Per Share * 4) / Current Share Price

Question 25

Debt-to-EBITDA

Answer 25

Debt / EBITDA. This ratio can be viewed as a measure of how many years of a company’s cash flows are needed to repay its debt.

Question 26

Debt-to-total-capitalization

Answer 26

Measures a company’s debt as a percentage of its total capitalization (debt + preferred stock + noncontrolling interest + equity).

Question 27

Coverage

Answer 27

Refers to a company’s ability to meet its interest expense obligations. Coverage ratios are generally comprised of a financial statistic representing operating cash flow in the numerator and LTM interest expense in the denominator. EBITDA, (EBITDA - Capex), or EBIT / Interest Expense

Question 28

LTM

Answer 28

Prior Fiscal Year + Current Stub - Prior Stub

Question 29

Calendarization of Financial Data

Answer 29

Accounting for any variation in fiscal year ends among comparable companies.

Question 30

Next Calendar (CY) Sales

Answer 30

((Month # * FYA Sales) / 12) + ((12 - Month #) * NFY Sales / 12)

Question 31

Income Statement Order

Answer 31

Sales 
COGS
Selling, General & Admin
Restructuring Charges 
Operating Income (EBIT)
Interest Expense 
Pre-tax Income 
Income Taxes 
Net Income
Weighted Average Diluted Shares 
Diluted Earnings Per Shares

Question 32

EV/EBIT

Answer 32

May be helpful in situations where D&A is unavailable (e.g. when valuing divisions of public companies) or for companies with high capex.