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Comparable company
analysis:
Importance of comparability
Abstract In undertaking a valuation of a business it is common to reference other companies which are comparable. Comparable companies can be used as a valuation cross check and / or assist in developing the discount rate. The identification and selection of comparable companies is based on professional judgement which may vary between accountants. Adopting a reasoned basis for selecting comparable companies will enhance the robustness of the valuation engagement.
Comparable company
analysis is a
fundamental tool
used in almost every
valuation
Identifying comparable companies The process of using metrics of another business of similar size, industry or other characteristics is referred to as a comparable company analysis. The metrics of the comparable company or companies are used to create benchmarks. The selection of a comparable company is based on a number of attributes and assessing whether the similarities are reasonable enough to include as a benchmark. This selection process is imprecise and requires professional judgment. Comparability can be considered by profiling both business characteristics and financial characteristics, some of which are shown in the following table: Business characteristics Financial characteristics Industry / Sector Size: Enterprise value, Revenues, Profits Products and Services Profitability Customers or End market Growth Distribution channels Return on investment Geography Gearing or Credit profile
When selecting
comparable
companies it is
important to consider
a range of business
and financial
characteristics
- Geography, demography & regulatory environment: The geographic location of a company and its operations will impact comparability since different regions impact the expected growth rate, opportunities, potential risks and the cost structure of the businesses. Further, the potential size of the market will differ, the regulatory regimes differ, buying patterns differ and cultural influences vary. Further, it may be unreasonable to compare a nationwide company to a company that operates in only one state, despite having similar employee and revenue numbers. Australian companies and the markets they operate in can be relatively small when compared internationally and the macro-economic environment may make companies non-comparable due to: o Market size and competitive landscape o Expected growth and inflation rates o Expected interest rates o Differences in accounting standards o Domestic regulations and taxes
- Profitability Profitability measures the ability to convert sales into profit by use of ratios or margins with gross profit, EBITDA, EBIT or net profit as a numerator and sales as the denominator. Depending on the industry it may also be measured on a per unit basis (e.g. customer or tonne). All else being equal, higher profit margins translate into higher valuations and determining a company’s profitability versus its peers is key when benchmarking.
- Gearing Gearing refers to the level of debt in a company. It can be a useful tool for comparability purposes as it is an indicator of risk. Generally, the higher ratio of debt to
The geography of a
company’s operations
can affect
comparibility due to a
number of macro-
economic factors
assets, the riskier the business. If the gearing levels differ substantially it may be inappropriate to apply a benchmark since the outlook and risk profile differ. Importance of comparability Differences of opinion can arise as to the comparability of companies and it would be argued the inclusion of a non- comparable company in a benchmark would distort the analysis undertaken. For example when creating a beta factor benchmark for the iron mining industry in Australia, if comparable companies are sought for a small iron mining business then BHP Billiton Limited, Rio Tinto Limited and Fortescue Metals Group Limited may distort the benchmark due to factors including their profitability, position on the cost curve and size of ore reserves. In assessing comparable companies for a small iron ore producer, these companies would therefore be excluded. The betas for ASX listed iron ore miners at 30 June 2016 are as follows: Company Beta as at June 2016 BHP Billiton 1. Rio Tinto 1. Fortescue Metals Group Limited 1. BC Iron Limited 2. Atlas Iron limited 2. Pioneer Resources Limited 2. Iron Road Limited 1. Average: all companies above 1. 92 Average: excluding BHP, Rio Tinto & FMG 2. 35 The average beta for all companies is 1.92, however once the large companies are excluded the beta is 2.35.
Assessing appropriate
comparable
companies can have
material impacts on
assessments of value
