Comparable Company Analysis (CCA) Tutorial (21:36)
In this tutorial, you’ll learn all about Comparable Company Analysis (CCA), also known as “Public Comps” or “Comps” – including why it works, what it tells you, and how to complete the process efficiently without access to expensive subscription services.
What is Comparable Company Analysis (CCA)?
Comparable Company Analysis is an example of a valuation methodology you can use to value companies.
For example, if a company’s share price is currently $50, what is it truly worth? $50? $100? $25? Something else?
If the company is worth more than $50 per share, then it might be undervalued and worth investing in.
If it’s worth less than $50 per share, then it might be overvalued and worth avoiding.
Valuation methodologies, such as Comparable Company Analysis (CCA), let you estimate a company’s intrinsic value or implied value, and how it differs from the company’s current market value.
You calculate a company’s “Implied Value” – what it should be worth – based on what other, similar companies in the market are worth.
For example, Company A has an Enterprise Value of $1,000, with an EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization, a proxy for cash flow from operations) of $100 and, therefore, an EV / EBITDA of 10x.
Other, similar companies in the market have EV / EBITDA multiples between 11x and 13x.
Therefore, Company A should also trade at an EV / EBITDA of 11x to 13x, and its Enterprise Value should be between $1,100 and $1,300.
As a result, Company A might be slightly undervalued right now, and if we like its qualitative, market, and competitive factors, we might decide to invest in the company.
Unlike a Discounted Cash Flow (DCF) Analysis, which is based mostly on your views of Company A’s long-term prospects, CCA is based on the financial markets’ near-term views of the industry.
A DCF depends on your projections for Company A’s Unlevered Free Cash Flow 5, 10, or even 20 years into the future, while CCA depends on very recent financial performance and near-term expectations for similar companies over the next 1-2 years.
If a DCF is “real valuation,” then Comparable Company Analysis is a supplemental methodology.
Its usefulness depends heavily on how correct the market is, and how “comparable” the comparable companies truly are.
How to Do Comparable Company Analysis: The Process
To value a company with CCA, follow these steps:
- Step 1: Select an appropriate set of comparable public companies.
- Step 2: Determine the metrics and multiples you want to use.
- Step 3: Calculate the metrics and multiples for all the companies.
- Step 4: Apply the median or 25th or 75th percentile multiples from the set to your company to estimate its Implied Equity Value and Enterprise Value.
Comparable Company Analysis Template
Click here to download a template for comparable company analysis, based on the example below for Steel Dynamics.
Here’s a screenshot of this template:
Comparable Company Analysis Example
Suppose that we’re valuing a company such as Steel Dynamics [STLD], a steel manufacturer based in the U.S.
Here’s how we might follow the steps above to do this:
Step 1: Select an Appropriate Set of Comparable Public Companies
You normally screen companies by geography, industry, and financial “size.”
Ideally, you want 5-10 companies in the set; ~50 is too broad to be useful, and a set of 1-2 companies is too little data to be useful.
We used the following screen for Steel Dynamics:
- Geography: U.S.-based companies only
- Industry: Steel Manufacturers
- Financial “Size”: Revenue between $1 billion and $20 billion
We did this via Capital IQ, but if you do not have access, you could also use a site like Finviz.com to complete a similar screen:
This initial screen matters because you want the companies in the set to have similar Discount Rates, i.e., similar risk and potential returns.
It all goes back to the most important formula in finance:
You want the comparable public companies to have similar Discount Rates and Cash Flows so that differences in their Growth Rates explain differences in their valuation multiples.
That way, if one company has a higher expected growth rate, then it should trade at higher multiples (in theory…).
Step 2: Determine the Metrics and Multiples You Want to Use
Normally, you want 1 sales-based metric and 1-2 profitability-based metrics and their corresponding multiples, over both historical and projected periods.
Example metrics and multiples might include Revenue, EV / Revenue, and Revenue Growth; EBITDA, EV / EBITDA, and EBITDA Growth; and Net Income, P / E, and Net Income Growth.
You use historical financial results, usually from the last fiscal year or the Last Twelve Months (“LTM”) because they are based on real events that actually happened.
However, they can also be distorted by acquisitions, divestitures, and non-recurring events such as write-downs and impairments, so you also use projected financial metrics, such as each company’s projected Revenue and EBITDA over the next 1-2 years.
These projected metrics better represent the company’s “steady state,” but, like all forecasts, they often turn out to be wrong.
However, that’s not a huge issue because all valuation is based on future expectations.
If you are wrong, and the entire market is also wrong, you could still make money – as long as you’re less wrong than the market.
Here, we used Revenue, EBITDA, and Net Income, and we also looked at each company’s growth rates and margins.
Step 3: Calculate the Metrics and Multiples for the Comparable Public Companies
You calculate each company’s Equity Value and Enterprise Value first, get the historical figures from annual and quarterly reports, and get the projected figures from online sources such as Finviz or Zacks or equity research reports.
These sites list each company’s Market Cap (AKA Equity Value), and you can click through and retrieve the company’s Debt and Cash balances to calculate Enterprise Value.
For the Enterprise Value calculation, you can assume Enterprise Value = Equity Value + Debt + Preferred Stock + Noncontrolling Interests – Cash & Investments.
Technically, more items might go into it, but for a quick analysis, you should not spend time poring through the company’s filings to find other items.
The historical financial metrics come directly from the company’s financial statements:
If you can’t find anything on these sites, another good source is Yahoo Finance, which usually has Revenue and EPS projections for U.S.-based public companies.
Once you have all the numbers, you calculate the valuation multiples for each company with simple arithmetic.
We’re doing some error checking here to prevent multiples less than 0x and greater than 100x and to handle the case where financial data is not available, but that’s not completely necessary:
Step 4: Apply the Median or 25th or 75th Percentile Multiples from the Set to Your Company to Estimate its Implied Equity Value and Enterprise Value
Then, you calculate the minimum, 25th percentile, median, 75th percentile, and maximum for each multiple and multiply them by the appropriate company figures (e.g., LTM EBITDA by the median LTM EV / EBITDA multiple from the comparable public companies).
We use the built-in Excel functions to calculate the percentiles first:
Then, on the Valuation Summary Sheet, we calculate the Implied Enterprise Value for each multiple, pairing it with Steel Dynamics’ corresponding metrics:
To move from Implied Enterprise Value to Implied Equity Value, we reverse the normal “bridge” and add Cash and non-core assets and subtract Debt and Preferred Stock.
And then we divide by the diluted share count to get the company’s implied share price for this specific multiple:
This analysis gives us all the implied share prices across the range of multiples, but it’s a bit difficult to see the results because there are so many numbers on screen.
So, we usually create a football field valuation using charts and graphs in Excel.
It might look something like this for Steel Dynamics (note that the dates do not match up to the ones above because this was taken from a different version of the file):
From this graph, our quick conclusion is that Steel Dynamics is likely overvalued.
Its share price at the time of this analysis was close to $25.00, which is above the median implied share price of each methodology, and close to the 75th percentile for some of them.
There may be qualitative factors that explain that, and the DCF might tell us something quite different – but at first glance, this company seems richly valued.
That does not mean it’s a great idea to “short,” or bet against, the company, as that would require further analysis of the market, competitors, and regulatory factors.
Companies can stay mispriced for long periods unless specific events force their share prices to adjust.
Completing the Analysis Quickly and Cheaply
We used Capital IQ to find data for the analysis above.
Search by the name of the company you’re valuing on these sites and then click through to the “Industry” section to find its peers.
Then, click through to “Financial Highlights” or “Statements” to find the projected numbers.
One common issue is that these sites contain projections for Revenue and EPS (Net Income / Share Count), but not metrics such as EBIT and EBITDA.
You can make your own estimates by applying the EPS growth rate to the historical EBIT or EBITDA figures.
For example, let’s say the company’s EBITDA in the last fiscal year was $1,000 and its EPS was $4.00.
Its projected EPS according to the online sources is $4.25, which is a 6.25% growth rate ($4.25 / $4.00 – 1 = 6.25%).
Therefore, you can estimate its projected EBITDA as $1,062.5, or $1,000 * (1 + 6.25%).
This method stops working over much longer periods, such as 5 or 10 years, but it’s fine if you just need the numbers for the next 1-2 years and you have no other sources.
This analysis is often more complicated and time-consuming in real life because:
- You may have to search through each company’s filings manually and look for the financials rather than relying on automated services.
- You might have to determine whether or not an expense is non-recurring and then adjust the company’s financial figures.
- And you may have to “calendarize” the financials if, for example, one company’s fiscal year ends on June 30th but another’s ends on September 30th.
We cover these topics in our full courses on financial modeling, but if you’re completing a quick analysis, you can safely ignore them.
Focus your time and effort on selecting the right set of companies and drawing the correct conclusions, and avoid “premature optimization.”
Comparable Company Analysis Pros and Cons
Summing up everything above, here’s how you can think about the pros and cons of Comparable Company Analysis:
- It’s based on real market data, not far-in-the-future, overly optimistic assumptions.
- It’s quick to calculate and easy to explain and understand.
- There may not be truly comparable companies.
- It’s less accurate for thinly traded stocks and volatile companies.
- It may undervalue companies’ long-term potential.
- The market might be wrong!