Market Approach Valuation
Valuing a company or other asset by finding close market comparisons and evaluating them.
What is the Market Approach to Valuation?
A market approach valuation is valuing a company or other asset by finding close market comparisons and evaluating them. It is commonly done alongside intrinsic value analysis to create a valuation output for a company.
The market approach valuation has two main methods, trading comparables and acquisition comparables. These two approaches can help determine the current market sentiment of a company and what price would likely be paid to acquire the said company.
Conducting either of these methods follows a similar step-by-step process which ensures that proper due diligence is done. The market-based approach to valuation serves as a great reference to the ever-changing conditions of equity markets.
Public comparables paired with precedent transactions, and the respective valuation outputs they produce, are almost always paired with a form of intrinsic valuation.
Generally, this takes the form of a discounted cash flow analysis in which the company's future cash flows are projected via financial modeling, and then dismissed to find their respective present values.
The combination of intrinsic valuation and market approach creates what industry professionals call a valuation football field. Simply put, a valuation football field is a chart showing a company's various values found using different methodologies.
Market Approach Valuation: Trading Comparables
(A.K.A. public comparables or public/trading comps)
1. Compile a list of similar companies publicly traded on a major stock exchange.
It may sound simple enough, but this step is just as much an art as a science.
To find solid public comps, evaluate the business you are trying to value. What sector are they in?
Who are their customers/competitors?
What end markets do this business operate in? What about geography, growth profile, credit profile, etc.?
After finding this information, compile a list of publicly traded peers that fit under the same criteria.
2. Chart critical statistics, ratios, and other tools
Now that you have your initial list of public comps, it is time to gather and chart data.
Standard figures used for trading comp analysis include price-to-earnings ratio, sales, EBITDA, EBITDA and profit margins, EV/EBITDA, E.V./sales, and net income.
In certain instances, using sector or business-specific metrics may be appropriate for comparing your list of companies.
For example, if the company and its trading comparables operate in the online media space, subscribers would be a helpful metric.
Once these numbers are found for each company in the trading comparables list, charting them in Excel can help one visualize and analyze them effectively. In addition, calculating a median and average for each key statistic in Excel is a must-do.
3. Insert critical statistics of the company being evaluated and compared against its peers
Finally, add the necessary information for the company being analyzed and compared against its peers. Any significant discrepancies should garner further examination.
For example, if company A has similar sales, net income, and growth and credit profiles as company B but trades at a much lower P/E ratio, that should be considered. This scenario could signal an opportunity to buy an undervalued company.
Market Approach Valuation: Acquisition Comparables
(A.K.A. precedent transactions, M&A comps)
1. Compile a list of comparable companies that have been sold in recent years
Companies added to this list should follow the same criteria as the trading comps list.
Find your company's competitors, companies within the same sector, serving the same customers, and companies with similar geography, growth, and credit profile.
It is essential, first and foremost, to have at least a few precedent transactions to analyze. Still, additional weight should be given to acquisitions that have occurred recently in a similar market and under similar macroeconomic conditions.
What is considered recent years can depend on the situation, with the time frame changing on a case-by-case basis.
2. Locate key deal terms and chart metrics for precedent transactions
Some critical things needed to complete this step are transaction value and LTM (last twelve months) financial data such as EBITDA, sales, and EBITDA margin.
Charting these figures and the multiples involving LTM EBITDA and sales provide the basis for acquisition comp analysis. These multiples give you an idea of what the company being evaluated could sell for throughout different market conditions.
It is essential to note the nature of the acquisitions that were completed. Whether it was a strategic buyer, financial sponsor, hostile takeover, or other situation could impact the price and multiples paid for the acquisition.
3. Apply the median and average multiples paid for LTM EBITDA and sales to the company being valued
This step allows one to visualize the transaction value range for the target if it were acquired in its entirety. This figure will typically be more significant than other valuation methods because acquisitions of entire companies include a controlling premium.
To take this step further, divide the transaction value by the total outstanding shares to arrive at the transaction value price per share. Comparing this to the current market price can lead to valuable insights on whether the company is over or undervalued.
Advantages and Disadvantages of Market Approach Valuation
The value of anything is what someone is willing to pay for, meaning that taking a market-based approach is very important. A market-based process considers market sentiment and expectations, which isn't feasible through intrinsic valuation.
Market approach valuation also provides relativity to analysis, which can be easily measured and compared across comparable companies. It allows the researcher to take some comparables more seriously than others and derive an applicable range.
Moreover, market approach valuation is more accessible and less time-consuming than conducting a thorough D.C.F. analysis.
Considering market sentiment via a market-based approach leaves it susceptible to market movements' irregularities. If the market as a whole is over or undervalued, the conclusion could be skewed.
With that, the disconnect from the cash flows generated by the business causes this valuation approach to be open to irrational expectations of the market and ignorance of company-specific intricacies.
Because the market approach to valuation has advantages and disadvantages, it is crucial to add other valuation methods and tools when conducting analysis.
Whenever analysis is being done researching equities or companies, it is paramount to pair both market-based approaches, along with due diligence on the company itself and its financial performance.
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