In relative valuation, two companies can sell similar products and deserve very different valuations. Your job is to determine which differences explain their trading prices before applying those prices to another business.
When a client asks what its business is worth today, you can examine how investors price similar listed companies. Trading comps use those public companies to estimate a target company's value. A trading multiple expresses value relative to a financial measure, such as earnings or sales.
This is relative valuation: you infer value from other businesses' market prices. Selecting comparable peers requires looking beyond an industry label to the characteristics that drive value. Growth, risk, and cash generation help determine whether companies provide useful comparisons.
Start with the target's products, customers, and revenue model. A subscription software company may be a poor peer for a hardware manufacturer despite their shared technology classification. Then compare the following characteristics:
- Size: Examine sales, assets, or enterprise value. A small company dependent on one customer may face risks absent from a diversified competitor.
- Growth: Compare expected revenue and earnings growth over matching periods. Rapid expansion can support a higher multiple when it produces sustainable profits.
Common mistakes
- Treating a 10x EV/EBITDA result of $600 million as common equity. With $100 million of net debt and no other claims, equity is $500 million.
- Mixing historical and forward periods. A 16x forward P/E applied to $2 LTM EPS gives $32; matching $2.50 forward EPS gives $40.
- Adding depreciation twice. If $60 million already represents EBITDA, adding another $10 million overstates a 10x enterprise valuation by $100 million.
Bottom line
- Select peers using industry, size, growth, margins, and capital-structure profile.
- Enterprise multiples produce enterprise value; P/E produces common-equity value or share price.
- Bridge from EV by subtracting debt, preferred equity, and noncontrolling interests, then adding cash.
- Match financial periods, valuation dates, accounting definitions, and dilution assumptions.
Exam shortcut
Circle the requested output first: enterprise value, common-equity value, or price per share. This identifies where your calculation must stop. Mark the denominator's period before touching the calculator. “Next year” requires forward earnings; “latest twelve months” requires historical results. Sort peer multiples before locating the median. With an even count, average only the two middle observations. When the stem gives EBIT, look for depreciation and amortization before applying EV/EBITDA.
The full lesson (about 3,763 words, 25 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- A6
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