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Why do we care about Market Comps?


vegaseller
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Most people's consideration of valuations, and including professionals simply boils down to

- Market comps EV/EBITDA are 7 and this company is 9, therefore it is expensive.

- The more prudent does some sort of growth CAGR normalization

 

But fundamentally aren't companies suppose to be unequal and subject to the 80/20 rule? Wouldn't the best company be significantly better run and better compounders than the #2/#3, etc. Then why do comps matter?

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I'm on the younger side, but I'll give you a basic answer and see what the group thinks. Comps allow investors to see if a company is undervalued or not. Usually the analyst will look at a group of company's and assign a common metric so it's easy to see if Company A is cheap relative to Comoany B. It is also helpful to see the valuation when companies do not have identical products or market size.

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Ehh...I use it as kind of a gut check.

Doing a completely private valuation is essentially saying you know everything better than the market does. And maybe you do, but it's helpful to see what the general consensus is around companies in the same industry. It's a triangulation tool. So yea, maybe you think P&G is a bit better than Unilever and deserves a slightly higher earnings multiple, but if all the CPGs are trading around 20x earnings and your valuation comes in at 35x, it gives you a second to pause and re-evaluate.

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I think peer comps can be a valid data point, but valuation really needs to focus on the individual company. In my opinion, peer comps are way overemphasized as a whole in investment write-ups. The book Valuation really helped me crystallize my thoughts around peer comps and I ended up writing a blog post about it--might be helpful to you vegaseller.

 

https://traviswiedower.com/2017/01/31/peer-group-valuation-is-mostly-useless/

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Peer comps work because psychology works.

 

An executive goes to sell his company.  He isn't a valuation guru like those on here.  Some underlying says "All of our competitors have sold for 15x EBITDA" and now he thinks "We should get at least 15x EBITDA, we're better than our competitors."

 

Comps are literally how the entire world works.  When you go to a garage sale and look at a vase do you think "I wonder how much cash flow can be generated from this?" No, you think "I've seen similar vases sell for $45 and this one is $25, it's a deal."  Same with clothes, same with cars, same with literally everything that is for sale.

 

Comps are like technical analysis.  Yes, there are 'true believers' who think that a DCF is the only true way to value something.  But if the rest of the market values on comps then that means comps will work.

 

I used them as a first pass filter.  If everyone in the industry is 15x EBITDA and some company is at 5x EBITDA then what skeletons are hiding? Why is it cheap?  If everyone is at 15x and a company is at 15x is there a potential for hidden value? Sure maybe, but you're digging deep into a haystack at that point.

 

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