[Pro] 17 - Comparables

Comparables are a great tool, but beware of how you apply them

Key points:

1. Valuation multiples are subject to some challenges that need to be considered before applying them. Companies can value their assets differently and apply different accounting practices to their businesses which can make comparisons challenging.

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Now there are a few issues with comparables that we’ll discuss more deeply here. Almost all of these issues will relate to how comps don’t actually compare companies in an apples to apples fashion. The first problem is that it’s difficult to find a set of companies that can truly be compared with each other. Companies often have different growth rates, risk profiles, profitability margins, capital structures, access to human capital, brand recognition and loyalty. These are often difficult to capture in a simple multiple. Multiples may not be able to give you an accurate value, but they can give you a ballpark, ceiling, and floor for which a valuation makes sense.

The first challenge to consider is the cyclicality of businesses and the timing for their reported metrics. This is the first place where comparability starts to fall apart. For example, consider two grocery store corporations like we did in the open access article. Consider a grocery store focusing on promoting goods in the summer vs a grocery store that discounts during the holiday season, their quarterly revenue will be very different in the summer and the winter even if their total annual revenue is similar. You could use a trailing twelve month (TTM) revenue figure for your valuation multiple, but then your valuation metrics will be lagged by at most one year, and the impact of the seasonality will still come through in the data. There are complex seasonality adjustments that can also be applied to the data to make them more comparable.