Understanding relative valuation – comparative company analysis
Relative valuation relies on the theory that, in general, similar companies will produce similar results. This may be a bit simplistic, but in a discipline that involves a lot of assumptions and estimates, relative valuation is popular among analysts as it provides a plausible way to arrive at the value of a business that is quick and simple. The actual calculations are straightforward. The difficulty is in identifying comparable companies. The main criteria to consider are as follows:
- Industry – With reference to your major source of income, identify the appropriate industry to which the company belongs and look for examples within that industry class.
- Size – The relationship between size and profits is not exactly linear. A company with twice the asset base will not necessarily make twice as much profit. There may be economies of scale and access to restricted benefits as a result of...
