Comparison of business with other peers is an important tool in understanding the real value of any company. A company’s financials on a standalone basis do not show any picture of the company’s real value. E.g. Company A with a profitability of 25% is not necessarily a better performing company than a company with a profitability of 10%. i.e. We need to see the company’s performance vis-a-vis its peers in the same industry or same business segments. In the example above, Company A could be grossly underperforming as profitability of its peers could be in higher 30s. Consequently, Company B could be operating in an industry wherein the average profitability is only 5%-6%. Hence, whenever we have do a business valuation, apart from the DCF method, we also need to conduct a relative business valuation of the company. Comparables like Price / Earnings, Enterprise Value / EBITDA, Enterprise Value / Sales. Price / Book Value and many more; which multiple to use depends on the type of industry in which the company operates.
E.g : The EV/EBITDA ratio is a financial metric that measures the return a company makes on its capital investments. This ratio is often preferred to other return metrics because it evens out differences in taxation, capital structure and asset classes.
Similarly, the P/E ratio is a valuation metric that compares a company’s stock earnings per share (EPS) to its current market price. This metric is widely known and used as an indicator of a company’s future growth potential. The P/E ratio does not reveal a full picture, and it is most useful when comparing only companies within the same industry or comparing companies against the general market.
Another important aspect here is the sustainability of the business and the margins. Significantly higher margins might not be sustainable for longer term of the business and the same needs to be further investigated and factored in to the business valuation by applying discounts. On the other side, if the company has a Unique Selling Proposition (USP) as compared to its peers in the same industry (say technical know-how, distribution network, operational expertise, etc) shall command a premium which again should be factored into the business valuation.
— Vishal Bhambhani, CFA
(Vishal is a CFA Charterholder and an MBA-Finance from Sydenham Institute of Management Studies, Research and Entrepreneurship. He has over 8 years of experience in the investment industry. Currently, he is working as Deputy Vice President at Blend Financial Services Ltd. In the past he has worked with Centrum Capital, SBI Capital Markets, IL&FS Maritime Infra, etc. He is also a volunteer for CFA Society India and a mentor for the CFA Institute Research Challenge)