In this article, I will show you how to apply comparable company analysis using valuation multiples, and will use this valuation method to value a real company in the stock market. Comparable company analysis (aka relative valuation or valuation using multiples) is the most popular valuation practice, where you're comparing a company to its peers and implying what it's worth based on appropriate relative trading multiples. This is based on the premise that similar companies share key business and financial characteristics, performance drivers, and risks.
Analysts and investors can therefore determine a company's relative position among peer companies, primarily based on the current value from market condition, and can determine a valuation. Like all valuation methods, relative valuation does come with its advantages and disadvantages as well, so we'll also discuss best uses for relative valuation and how viable and effective the method is when valuing companies in the stock market.
Relative valuation is dependent on how similar assets are priced in the market. The objective with relative valuation is therefore to value an asset based on how similar assets are currently priced in the market. This is different from absolute valuation methods such as the discounted cash flow (DCF) calculation, as this entails estimating the intrinsic/fair of a company based on its cash flows and growth potential without comparing it to other similar assets whatsoever.
To better illustrate the principle of relative valuation, we can look at how property is valued within the real estate market. To begin, a property on its own represents a productive cash generating asset, which implies the property has an intrinsic value. However, in most cases, to understand the real price of a property, you must compare its price to other nearby similar properties that have recently sold. For example, if an identical similarly-sized house sold across the street recently for $500,000, it's unlikely that you'll be able to buy an identical house now for half the price ($250,000).
In the same way, companies in the stock market all have an intrinsic value that can be more or less estimated, and most are similar-enough to other companies within their industry. Therefore, the concept of relative valuation can be applied to companies as well.
Because relative valuation is based on the value of similar assets, you must evaluate a company relative to its peers, such as those within the same industry/sector and those with a similar business model. Typically, these peers would be considered direct competitors, such as those operating in the same or in a closely-related industry/sector, and/or companies with the same size, quality, and even growth attributes. Ultimately, this decision on selecting the appropriate peers will be based on your knowledge of a particular company and its respective industry/sector.
Now that we understand the concept of relative valuation, we can look at the general steps to completing a relative valuation. These five steps, as shown in the table of contents, are listed below as well:
In this article, we will complete a comparable company analysis using valuation multiples for Cedar Fair (FUN), a company that operates amusement park-resorts throughout the U.S. and Canada.
You can see Cedar Fair's stock price performance overtime in the chart below:
The first step is to determine an appropriate set of company comparables (aka comps). This is the foundation of a relative valuation approach. Although this can be fairly simple and intuitive for companies in certain sectors, it can also be quite challenging for other companies and/or industries where peers are not as obvious.
Therefore, before you even begin a relative valuation approach, you must understand the company you're trying to value (the target company) thoroughly. Put simply, this entails considering the target company's business and financial profile. I would begin by evaluating the target company's business profile first, as the financial profile measures typically confirm what you previously found.
Note: This list is based on Investment Banking: Valuation, Leveraged Buyouts, and Mergers and Acquisitions (2013).
Obviously, you need to select the right companies to compare the target company to. It's in your best interest to not rush through this due diligence process and make assumptions, otherwise your valuation model can be completely misleading. Ultimately, the more you read and study about a company, its sector, and its business operations, the more accurate your model may end up being.
As previously mentioned, the methodology for determining comps is relatively intuitive, and typically involves looking at companies within the same sector (or sub-sector) and those with similar sizes. However, this can be quite challenging for certain companies and industries where peers are not as obvious. Regardless, the actual selection of comps should not begin until you've thoroughly understood the target company.
For companies with no clear comps, one can examine companies outside the target company's industry/sector and select companies that share similar business and financial characteristics. For further analysis, The multiple of a specific company can also be compared to the average of that industry/sector, instead of select comps. Additionally, multiples can also be compared to the company's long-term historical averages to determine how undervalued or overvalued the current multiple is trading at.
For example, the graph shows that Cedar Fair's current price-to-sales (P/S) ratio is extremely overvalued, relative to the previous 15 years, due the effects of the pandemic (slower sales) and the company's current stock trading price. You could do the same with other ratios, key statistics, and multiples discussed later in this article, and then apply the ones most relevant to the target company's business model and industry/sector.
The initial screening stage focus is on identifying companies with a similar business profile. In your business and financial profile valuation process, you may have uncovered potential comps. The target company may also discuss its competitors to shareholders during earnings calls or in their 10-K annual reports, particularly in the "management's discussion and analysis" section. Besides this, you can use various financial services websites or a simple Google search to uncover additional comps.
The websites I use include:
Cedar Fair's comps can be determined rather quickly given its business model, which revolves around operating its amusement parks, water parks, and resort facilities in the U.S. and Canada.. For context on where Cedar Fair fits in the industry, they're the world's 8th largest amusement park by attendance (4th largest in the U.S.). The largest competitors include Walt Disney Parks & Resorts, Six Flags Entertainment, and SeaWorld Parks & Entertainment, which are the "pure play" competitors to Cedar Fair.
We can also look at Cedar Fair's revenue breakdown, to better understand the company's operations and what peers we should be looking for. This is broken down in the pie charts below from 2018-2020:
As you can see, Cedar Fair drives much of its revenue from amusement park admissions, which are simply just the admission fees customer's pay to access the parks, including parking fees. Food, merchandise and games that the park offers both inside and outside the park are also significant revenue drivers. However, only about 15% of its revenue comes from "accommodations and other," which includes "extra-charge products, including premium benefit offerings such as front-of-line products and online transaction fees charged to customers," per Cedar Fair's most recent 10-K annual report.
Based on Cedar Fair's business model, revenue breakdown, its scale, and where it operates, among other business and financial profile measures, the list of competitors I will use for this relative valuation model are listed below:
I'll also be taking a closer look into the top two publicly traded movie theater companies in the U.S. (by market capitalization), as they're entertainment-focused that also happen to generate much of their revenue from ticket sales (admissions) and food/beverage, like Cedar Fair, while also being impacted heavily by the pandemic like amusement parks have been. Lastly, I'll consider Marcus Corporation, whose business model is not entirely dependent or directly related to amusement park resorts or theaters.
After identifying these similar companies (comps), the next step is to find financial data, and then aggregate and standardize the data so that it can be compared.
Once the initial comps are determined, you must locate the financial data needed to analyze the selected comps and calculate trading multiples, key financial statistics, and ratios (in step #3). To aggregate and standardize data, you can use the most recent 10-K, 10-Q, 8-K, or Press Release information to find the necessary financial information. The Proxy Statement and credit rating agencies may also help in providing relevant information.
Once you have the necessary financial information for all of the comps, you should create an "input page," where the calculation of the key financial statistics, ratios, and multiples can be completed. This will then feed into the output sheets that are then used to benchmark the comps. However, because these multiples are already calculated for us in our example (using Atom Finance), this process is not required.
Using a financial data website can therefore speed up this process quite significantly. Below are four free websites I like to use for relative valuation (some may require registration):
If I were using Atom Finance, as I did in this article, I would download the two Excel sheets ('default columns,' which has multiples data and 'returns,' which has various performance information) and then put them on one spreadsheet. Then, I would clean this data so that the formatting is consistent throughout (i.e., ensure all data is in number format). Afterwards, I would copy relevant data from each sheet into one sheet, and then identify which multiples are the most relevant depending on the company and the industry it's in, which the next step covers.
Because companies can have dramatically different sizes, revenues, and bottom line earnings, trading multiples, ratios, and other key statistics are used to make comparing two or more different assets a lot easier. Multiples are therefore used in relative valuation to give investors an idea on how "expensive" a company is, relative to its peers.
The logic with valuation multiples, is that the company you're trying to value should have similar earnings to its competitors, given that it's operating within the same industry/sector and possesses similar characteristics. The default approach to valuation multiples is rather straightforward, in which a table (or multiple tables) are organized so that different valuation multiples from similar companies can be compared to one another. In theory, these ratios should help you to identify how cheap or expensive a business is.
In general, valuation multiples can be thought of the ratio between the valuation of a company and a particular trading metric:
Valuation multiple = Value of a company / Financial or business metric
Most valuation metrics therefore follow the same approach, where the company's stock price, market cap, or enterprise value are evaluated in respect to some other metric, such as a firm's profit or cash flow.
Below are the key financial statistics that are standard in the relative valuation approach:
These key financial statistics are described in detail below.
Equity value represents a company's fully diluted shares outstanding (different from basic shares outstanding) multiplied by the current share price. In comparison to other companies, this measure is only useful for understanding the relative size of a company.
Equity value = Share price * Fully diluted shares outstanding
Fully diluted shares outstanding = Basic shares outstanding + "In-the-money" options and warrants + "In-the-money" convertible securities
Basic shares outstanding can easily be found from the first page of a company's 10-K or 10-Q. Otherwise, it is usually reported on most financial data websites as well. "In-the-money" options and warrants can be calculated using the "treasury stock method"(TSM). "In-the-money" convertible securities can be calculated with the "if-converted method."
The easier method, however, is to just look at the income statement in the most recent 10-K or 10-Q report, and look towards the bottom of the income statement where a line item called "Shares used in computing earnings per share (EPS)," or something similar should be stated. Then, a sub-section should show Basic and Diluted shares outstanding, and you can use this Diluted figure to calculate equity value. The accompanying "notes to consolidated financial statements," found under the financial statements, will typically provide you with more detail on this calculation as well.
This is outlined below from Cedar Fair's most recent (FY 2020) 10-K annual report, on its income statement:
If you know the enterprise value, you can calculate equity value as well (without having to worry about diluted shares outstanding):
Equity value = Enterprise value - Debt and debt equivalents - Non-controlling interest - Preferred stock + Cash and cash equivalents
Note that debt and debt equivalents, non-controlling interest (aka minority interest), and preferred stock are subtracted because they represent the share of other shareholders.
For insight on the absolute and relative market performance, investors can look at the company's current share price as a percentage (%) of its 52-week high. This widely metric gives investors perspective on valuation, on the current market sentiment, and on the overall outlook for the broader industry/sector. Comparing the target company and the comps "% of 52-week high" will give you insight on whether the target company is in line with its peers from a performance and current market value perspective, or if there are individual things that may be affecting the company's performance.
Ideally, your comps should be within a 5% deviation range from your target company's % of 52-week high figure. So, if the average of five comps (for example) is 50%, and the % of 52-week high is between 45% and 55%, then we can say that from a market performance perspective and business/financial profile perspective, they are very similar -- which is what we're looking for in comps.
You can calculate the % of 52-week high using the formula below, which is rather intuitive:
% of 52-week high = Share price / 52-week high
This will be calculated and examined in our Cedar Fair example as well.
Enterprise value is the sum of all ownership interest in a company and claims on its assets from both debt and equity holders. Changes in a company's capital structure will not affect its enterprise value, which is why enterprise value multiples are used more frequently than equity value multiples. Therefore, by using the enterprise value, you're conducting an unbiased comparison for different companies that likely have different capital structures. Ultimately, this can help in setting up a more "fair" environment to compare companies. On the other hand, with equity value multiples, the capital structure of comps can influence the resulting equity value.
The enterprise value calculation is shown below:
Enterprise value = Equity value + Total debt + Preferred Stock + Non-controlling interest - Cash and cash equivalents
To determine whether or not a company has preferred stock outstanding, you can look under the shareholders' equity section of a company's balance sheet. Note that many companies do not issue preferred stock. In this case, the preferred stock figure would just be zero (nonexistent).
Non-controlling interest is also called "minority interest." This can be found in the balance sheet, under the non-current liability section or equity section. This will only show up if the company owns more than 50% of another company (the subsidiary), in terms of the subsidiaries voting stock.
Cash and cash equivalents can simply be found under the "current assets" section on the balance sheet, which are the most liquid assets a company has. "Cash equivalents" refer to to short-term commitments that are likely accruing interest, like money market funds, that can be easily converted into a known cash amount.
Below is a list of common multiple profitability metrics you can calculate/use in your relative valuation approach, along with a more detailed description of EBTIDA and EBIT:
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), is a widely used measure for operating cash flow and measure of profitability, as it reflects the company's total cash operating costs for producing its products, ignoring financing costs and non-cash charges. EBITDA is free of differences that result from tax regime (i.e, tax expense) and capital structure (i.e., interest expense), which makes the figure ideal for an "apples-to-apples" comparison between comps.
EBIT (Earnings Before Interest and Taxes) is independent of tax regime and serves as a useful metric for comparing companies with different capital structures. It's often synonymous with "operating income," "operating profit," or "income from operations," found on the income statement. Because EBIT includes non-cash depreciation and amortization (D&A) expense, it's less indicative as a measure of operating cash flow.
Below is a list of common multiple leverage metrics you can calculate/use in your relative valuation approach:
Many publicly-traded companies in the U.S. report their financial performance in accordance with a fiscal year (FY) ending on December 31st. This corresponds to the calendar year (CY) end. However, not all companies report their FY end on December 31st, so any variation in fiscal year ends among comps must be addressed for benchmarking purposes.
You can use the formula below to "calendarize" the financial data for whatever metric you're using. In this case, I'll use sales as an example:
Next calendar year (CY) sales = [ (Month #) * (FYA sales) / 12 ] + [ (12 - Month #) * (NFY sales) / 12 ]
This is important to do (if needed), as trading multiples based on financial data for different periods can lead to a misleading comps valuation, especially for cyclical companies/industries.
Three common equity value multiples are the price-to-earnings (P/E) ratio, the price-to-earnings-to-growth (PEG) ratio, and the equity value-to-net income (EV/NI) multiple.
P/E ratios provide a measure on how much investors are willing to pay for a dollar of a company's current or future earnings. Typically, P/E ratios are typically based on forward-year earnings-per-share (EPS) figures, as investors are focused on future growth. Companies with higher P/E ratios than their peers tend to have higher earnings growth expectations.
P/E ratio = Share price / Earnings per share (EPS)
The current stock price is easy to find, but the earnings per share (EPS) figure is found using the formula below:
Earnings per share (EPS) = (Net income - Preferred dividends) / Weighted average of common shares outstanding
P/E ratios (and many other multiples) can also be divided into different categories, as there are different variations of valuation multiples:
In general, a lower P/E ratio is "better" as it means that you get more earnings from your investment. However, this can also mean that investors aren't very confident about the company's current standing. On the other hand, a higher P/E ratio means investors are paying a higher price for the stock when compared to its earnings. In addition, as the P/E ratio increases, it shows that the current investor sentiment is favorable, meaning investors are willing to pay a higher price for the stock. By contrast, a declining P/E is an indication that the sentiment is turning bearish.
Compared to other ratios, the PEG ratio is unique as it factors in growth, and is therefore a much more valuable multiple than the P/E ratio itself (in most cases). In other words, because the PEG ratio factors in expected levels of growth across different comps, it's a better multiple to compare with its peers, even if they are in different business life cycles. This ratio can also be divided up into the trailing PEG for historical growth rates, and the forward PEG for forward-looking growth rates.
PEG ratio = P/E ratio / Earnings per share (EPS) growth rate
The PEG ratio can therefore be used instead of the forward-looking P/E ratio, as it generally provides a more complete picture of a company's value. If the PEG ratio is below 1.0, it's indicative of an undervalued stock because you'd be receiving more growth than you're paying for. The opposite would apply for a PEG ratio above 1.0.
The EV/NI multiple is a ratio that illustrates how much an investor is willing to pay for a dollar of a company's current or future earnings. This is the better equity value multiple to use in many cases, as the P/E and PEG ratios ignore balance sheet strength and capital structure, among other reasons.
EV/NI = Equity value (EV) / Net income (NI)
The two limits to the EV/NI multiple are listed below:
Because enterprise value represents the interests of both debt and equity holders, it's used as a multiple for key financial statistics such as sales, EBITDA, and EBIT. Enterprise value multiples are therefore more appropriate when trying to value an entire business.
The most common enterprise value multiples are "enterprise-value-to-EBITDA" (EV/EBITDA) and "enterprise-value-to-EBIT" (EV/EBIT). These are the general valuation standards for most sectors, and they also act independently of capital structure, taxes, and depreciation and amortization differences among different companies.
EV/FCF compares the enterprise value to the company's ability to generate cashflow. The lower this ratio, the quicker a company can generate cash to reinvest in its business or payout to shareholders in the form of dividends.
EV/S compares the enterprise value to the company's ability to generate sales. However, sales (revenue), although it does provide an indication of size, does not translate well into profitability or cash flow generation, which is why it's typically less relevant than other enterprise value multiples.
Sector-specific multiples can be applied to certain industries/sectors if they are more relevant. These multiples use an indicator of market valuation (i.e., equity value or enterprise value) in the numerator and key sector-specific production/capacity, financial, or operational statistic in the denominator.
These sector-specific multiples can be divided up into "items affected by capital structure" (equity value (price) in the numerator) and "items unaffected by capital structure" (enterprise value in the numerator).
Items affected by capital structure:
Items unaffected by capital structure:
For Cedar Fair, to keep things simple, and because I'm interested in how it will perform in the future with the entertainment industry's current slump due to the pandemic, I'm going to be focusing on forward multiples. This means that I will get rid of any "LTM" or "TTM" (last/trailing twelve months) data that I received from Atom Finance. I'm also going to ignore EPS Growth (FY1), because many of these comparable companies, Cedar Fair included, did not generate much of a profit over the last year.
The next part of the analysis process is to examine the comparable companies (aka comps) and determine the target company's relative ranking and closest competitors. Again, the target company is simply the company you're trying to value. Benchmarking therefore serves to determine the relative strength of the comparable companies in relation to one another and the target company. This entails closely examining the similarities and discrepancies in size, margins, and growth rates, among other measures, between the comps and the target company. Ultimately, the objective is to determine the target company's relative ranking so that valuation can be framed accordingly.
The two steps for this process are as follows:
When benchmarking, you'll need to calculate the medians and means (averages) to get a better sense of where the comps are trading at. You should do this for each category and for the overall total as well. Additionally, you should title every column appropriately and organize them accordingly, as I did here for Cedar Fair:
Above is the standard format to use for a comparable companies analysis. As you can see, I focus on revenue in this example due the companies and industry I'm dealing with, and because profitability measures are not very applicable to non-profitable companies. EV/EBITDA is also not very useful or relevant for the "Movie Theaters & Other" category, especially for Cedar Fair, which is why I will not be using the median or average for this category to imply valuation. Moreover, it appears that Six Flags and SeaWorld are poised for higher growth than the other two comps in the "Amusement Park/Resorts" category, which makes sense given the reopening of amusement parks/resorts throughout the U.S. and other countries.
We can now use this benchmarked information to imply a valuation for Cedar Fair.
The final step utilizes the trading multiples of the comparable companies to derive a valuation range for the target company. This entails calculating and using the means (averages) and medians for the appropriate trading multiples (i.e., EV/EBITDA) as the basis for extrapolating an initial range, as previously illustrated. The high and low (outlier) multiples for the comps serve as further guidance in terms of a potential ceiling or floor for the valuation.
For our Cedar Fair example, now that we have everything benchmarked, multiples can now be used for valuation. In particular, we'll be using EV/EBITDA to imply a valuation for Cedar Fair. I used Yahoo Finance analyst estimates for Cedar Fair's revenue in 2021 and 2022. Then, I used Atom Finance and TIKR to provide me an estimate on EBITDA for 2021 and 2022. You can also use net income as a proxy for EBITDA if you're unable to find an accurate estimate for EBITDA, or just project one yourself based on your understanding of the company or the company's historical EBITDA growth rates.
These estimated financials for Cedar Fair are shown below:
Looking back at the comps table/image in the previous section, I decided to use the "Amusement Parks/Resorts" average EBITDA FY1 figure of 31.28x, because it's slightly more conservative. If I wanted a valuation range, then I could've used the 32.15x as well. Then, I used the EBITDA estimate for 2021 ($99.49 million), as it was more realistic, to make on estimate on the valuation of Cedar Fair. Finally, I divided by the fully diluted shares outstanding (shown before) to get the implied share price.
These steps are clarified below:
Step 1: 31.28x EV/EBITDA * $99.49 million EBITDA = $3,112.0472
Step 2: $3,112.0472 / 56.746 million diluted shares outstanding = $55.10 (implied share price)
Comparing this to the share price on April 23rd of $50.12, we can imply that Cedar Fair's current share trading price is undervalued on a purely relative basis (by 9.94%).
While relative valuation is rather intuitive, it does come with its advantages and disadvantages (like all other valuation methods). The two sub-section lists below should therefore give you an understanding on how viable the method is, depending on the target company and respective industry, and when it may provide the most use to the average retail investor.
Relative valuation is therefore most appropriate in an "apples-to-apples" comparison, not an "apples-and-oranges" comparison. Theoretically, the more confident an investor is with its comps, the more helpful performance, profitability, and leverage ratios will be in estimating an implied share price. For example, Delta (DAL) and Boeing (BA) have very similar business models and it may be worth comparing the two companies. However, the same could likely not be said for a dine-in restaurant and a fast food chain, even though they are both in the restaurant industry.
With relative valuation, your basis is that the market knows how to price every single business correctly (called the efficient market hypothesis), which is generally proven to be false. Relative valuation also gives no information on what a company's intrinsic worth is, and as a result, the stock may be undervalued on a relative basis but overvalued on an absolute basis (e.g., with a DCF calculation). I therefore believe the relative valuation approach, although useful at times, is inferior to other valuation approaches. In fact, using relative valuation methods may expose you to psychological biases (e.g., anchoring bias), where the target company and its growth trajectory may have changed and therefore the business may deserve to trade at a higher multiple. In short, all of this is not reflected in a valuation multiples approach.
To value a company using comparable company analysis (aka relative valuation or valuation using multiples), you must begin by identifying an appropriate set of peers (aka comps), which your model will be based on. Afterwards, you need to locate and then aggregate and standardize the appropriate financial data needed for all of the chosen comps. Then, you can select the appropriate trading multiples, key statistics, and ratios depending on the target company and its respective industry/sector. Next, you need to benchmark this information, calculate medians and means, and select a valuation multiple that best suites the target company.
The final step is to imply valuation, for example based on a median/average multiple such as EV/EBITDA, and determine a valuation by multiplying this figure to a future expected EBITDA figure. Dividing by the diluted shares outstanding will then provide you with an implied share price that you can then compare to the current trading price. A range of implied share prices can also be determined if you select another appropriate EV/EBITDA median/average multiple and repeat this process.
Although this process is rather intuitive and is often seen as a "shortcut valuation approach" for many companies, relative valuation fails to provide information on the growth prospects of the target company, the quality of management, the competitive position of the corporation, its cash flow generation abilities, and many other company-specific attributes. Nonetheless, relative valuation can be a good starting point for understanding a company's current market position, along with being particularly useful for companies with little-to-none in free cash flow, or those that are not profitable.
As a rule of thumb, in the short-term, valuation multiples are the primary drivers of stock price performance. However, in the long-run, business growth drives stock performance. Business growth is also typically a lot more easier to predict, which is why investors should focus on the business fundamentals and qualities first. In closing, while valuation multiples are likely so popular due to their simplicity, a discounted cash flow (DCF) valuation (based on absolute valuation) may give you an edge in the market, especially for long-term value investors who manage to develop a solid understanding of a particular business and its growth potential.
Disclaimer: Because the information presented here is based on my own personal opinion, knowledge, and experience, it should not be considered professional finance, investment, or tax advice. The ideas and strategies that I provide should never be used without first assessing your own personal/financial situation, or without consulting a financial and/or tax professional.