A key method used by financial analysts is Comparable Company Analysis (CCA). This approach takes the guesswork out of valuation by comparing a target company to similar businesses. Think of it as finding a company's look-alikes in the financial world. By analyzing the financial metrics of these comparable companies, or "comps,"  analysts can gain valuable insights into whether a target company is overvalued, undervalued, or priced fairly within its industry. 

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This extensive guide helps you find comparable companies for valuation. We'll look at the key factors to consider when selecting the comps and present useful resources and tools that make finding comps easier.

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What is comparable company analysis?

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Comparable Company Analysis (CCA) is a fundamental method used in the field of finance and investment to determine the value of a company. The analysis assesses the value of a target company by comparing it to other similar companies. It provides a tangible reference point for assessing a company's value relative to its peers. 

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The comparable companies, also known as "comps," form a comparable universe, and share similar characteristics such as sector, product or service, size, growth rate, and financial metrics. 

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Why is selecting the right comparable companies extremely important?

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Selecting the appropriate comparable companies is the key in conducting a meaningful analysis. The chosen comps should represent the same industry, market segment, geographic location, products and services, business model, and growth stage. The comps define how accurate the valuation will be. Analysts gain insights into whether a company is overvalued, undervalued, or priced fairly within its industry by evaluating key financial metrics such as enterprise value-to-EBITDA and EV/EBITDA multiples, among others. 

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A poor selection of companies can lead to inaccurate valuation results. Inaccurate comparables might misrepresent the target company's true value and undermine the credibility of the analysis. For example, basing the analysis on a company with entirely different geography, distribution channels and end market customers would cause the analysis to be skewed. 

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Through meticulous selection of comparable companies and a thorough evaluation of their financial metrics, analysts can arrive at a more accurate estimate of a target company's value. 

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How to choose comparable companies for accurate valuation?

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Here are key factors to consider when evaluating companies for the comparable analysis:

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  • Product or service: Future growth prospects are tied to the demand for the products or services. Companies in unrelated industries are affected by different risk and economic factors, regulatory environments, and competitive pressures. Companies in emerging, niche, or volatile industries may face greater uncertainty, competitive challenges, and market risks.
  • Business model: Companies with similar business models are likely to have similar cost structures, operational processes, and resource allocation strategies. If the comparable companies differ in their business models, their operational and financial characteristics are significantly different.
  • Size: Size indicates revenues, market share and industry influence. Larger companies potentially have more stable cash flow and financial performance. Size can also influence growth potential and cost of capital. Due to the lack of publicly available data, publicly traded companies are often used for CCA, making the comps rather larger than smaller in size.
  • Geography: Companies in different geographies operate in distinct markets and face unique competitive landscapes. Typically Western European companies are compared to others in the same area, and US companies to others within the country, for example.
  • Growth rate: Companies should be compared to peers in similar growth stages, as the stages influence expectations for future revenues and earnings, competitive pressure and customer demand.
  • Data availability: This is one of the most important factors that has to be taken into account. A company that could be great in terms of similarity is a poor comp if there is no information available to base the analysis on. This means that comps are often publicly traded.

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How to find comparable companies: Tools and resources

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Next we explain where to find comparable companies to conduct the CCA.

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Traditional methods: Using business databases, websites and news

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Traditional databases like Bloomberg and CapitalQ offer extensive and up-to-date financial data on a wide range of companies. This includes financial statements, ratios, stock prices, industry classifications, and more, which are used for comparable companies analysis. This comprehensive data pool facilitates thorough analysis. Company information can be also found across public records, business directories, and other openly available sources.

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Traditional databases are reputable and widely used in the financial industry. They maintain consistency in data presentation and format, making it easier to compare information across different companies. They can also offer historical data, enabling analysts to track companies' performance over time. 

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Although they include many benefits, there are also some downsides of these databases. The cost can be one factor, as access to premium databases like Bloomberg and CapitalQ often come with a significant cost. The platforms can be complex to navigate and their search options can still be somewhat limited, based on fixed industry codes, for example. This means that databases can still have limitations in terms of tailoring searches to very specific criteria. Although the companies strive to provide real-time information, there could still be instances of delayed updates or inaccuracies.

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New method: AI-driven databases

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AI-driven company databases, such as Inven, provide a highly efficient and comprehensive approach to identifying suitable companies for Comparable Company Analysis. These databases leverage advanced algorithms to aggregate data from diverse sources like company websites, industry registries, and LinkedIn, streamlining the process by centralizing this information. 

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The AI tools allow analysts to input a single example company. The AI then automatically scans and compares the data of the example company with that of all other entries in the database.  The tool scans websites and other sources to understand the type of business and features the original company represents, and finds results that match them. 

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This method ensures a precise and comprehensive list of companies that closely match the characteristics of the example company, saving valuable time and effort. 

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The search for comparable companies is also simplified by filtering other parameters. Users can narrow down results based on aspects like location, headcount, business model, and ownership. AI-driven company databases vastly enhance the efficiency and accuracy of CCA by facilitating the identification of relevant comparable companies within a single platform.

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Importance of quality information

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When making a decision about data collection strategy, it is reasonable to find databases that find all the relevant companies, so the comparison is not incomplete due to missing data points. 

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It is essential to use databases with good quality and up to date information. What is more, intuitive user experience and easy filtering (location, headcount, business model, ownership etc.) play a part in finding quality companies for analysis.

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Step-by-step guide to finding comparable companies with Inven

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Inven combines data from various sources, which allows analysts to find the most accurate comps to build the analysis on. Here is how to efficiently find comps with Inven’s tool:

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1. Identify the company for valuation

Start by understanding the company's business model, target market, and competitive landscape. This helps you to set criteria to find the right companies that are actually comparable. 

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2. Select the right criteria

Set the company in the valuation process as an example company. 

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Set filters on location, headcount, and ownership for the comps. Filter out other than public companies to more likely find results with enough data available. Narrow down the right company activity keywords you want to match. 

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Start the AI screener and get a list of companies. The AI tool compares the data of the example company to all the other companies in the database to find all the companies that match the example company. 

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3. Search companies with similar business models 

Instead of searching companies that have the exactly similar product, you can use the search to find companies with the same type of functions. 

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For example, if you are looking for companies that manufacture aluminum sheets, perhaps also companies that manufacture other kinds of similar heavy industrial products might work well in the analysis. Even if they don’t per se work with aluminum sheets, in case they match many of the other criteria, they can be included in the CCA.

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You can also reduce the weight of the keywords so that some results become excluded from the list. 

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4. Categorize the companies

After Inven’s tool provides you a list of companies, there is certainly still some variation in how well they match your CCA. Use the easy categorization tool to build priority categories based on your criteria. 

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Add to one list companies that are most relevant to the company you’re trying to value, and to the second the ones which have potential but operate in slightly different sectors. 

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Export lists for further analysis.

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5. Find acquisition information through ownership filter

One way to get an idea about the valuation of similar companies is to use Inven’s ownership filter. Select private equity backed companies in the same industry to scrutinize acquisition news and gain recent valuation data from them.

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Common mistakes to avoid 

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There are a few things worth noting in the CCA that can affect the valuation results:

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  • Including companies from non comparable areas (e.g. valuations in China are not comparable with the US)
  • Not taking enough companies to the list (using tools like Inven can help)
  • Not adjusting for special items in income statements
  • Not adjusting for different accounting standards (companies might be following different accounting standards e.g. IFRS vs FAS which requires adjusting the EBIT and EBITDA figures)
  • Using generic "industry codes" instead of NLP based, nuanced understanding of what the companies are doing to get the similar companies

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Inven uses exact keywords to find companies based on what they actually do. A database which finds all the desired results will make CCA more reliable.

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Additional resources

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Once you have found the perfect comparable companies, you can start the valuation process.

 

More information about how to do the CCA from here, or in Joshua Pearl’s and Joshua Rosenbaum’s book Investment Banking: Valuation, LBOs, M&A, and IPOs. 

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