COMPS VALUATION METHODS EXPLAINED: P/E AND EV/EBITDA

What Is Comparable Company Analysis (Comps)?

Comparable company analysis, commonly referred to as “comps”, is a relative valuation method used by investors, analysts, and corporate finance professionals to value a business by comparing it to other publicly-traded companies with similar characteristics. These attributes typically include sector, size, growth profile, profitability, and geographic footprint.

The approach relies on the assumption that similar firms should be valued similarly if their financial profiles and operating conditions are alike. It involves selecting a peer group of firms and applying key financial multiples such as Price-to-Earnings (P/E) and Enterprise Value to EBITDA (EV/EBITDA) to determine the subject company’s value.

Key Multiples Used in Comps Valuation

• P/E (Price-to-Earnings Ratio): Measures a company's share price relative to its net earnings. It is calculated as Market Price per Share divided by Earnings Per Share (EPS).
• EV/EBITDA (Enterprise Value to EBITDA): Measures the total value of a firm, including debt, compared to its earnings before interest, taxes, depreciation, and amortisation. It is calculated as Enterprise Value divided by EBITDA.

These metrics are widely used due to their simplicity and ease of comparability across businesses and sectors. However, they also bring specific limitations, depending on the firm’s accounting practices, capital structure, and other company-specific factors.

Steps in Performing a Comps Valuation

1. Identify the target company and its industry peers.
2. Collect financial and market data for each company in the peer group.
3. Normalise figures for comparability (adjusting for non-recurring items, etc.).
4. Calculate relevant valuation multiples (P/E, EV/EBITDA, etc.).
5. Apply the peer group’s median or mean multiple to the target company’s financials to estimate its value.

This approach provides a market-based perspective of valuation, reflecting current investor sentiment and sector trends. Yet, interpretation must be guided by a deep understanding of the financial metrics and their underlying implications.

Understanding the Price-to-Earnings Ratio

The Price-to-Earnings (P/E) ratio is among the most familiar and widely used valuation metrics in equity markets. It represents how much investors are willing to pay for a company’s earnings. The formula for P/E is:

P/E = Market Price per Share ÷ Earnings per Share (EPS)

Applications of the P/E Ratio

Analysts commonly use the P/E ratio to compare a company’s valuation relative to peers or to its own historical valuation range. Higher P/E ratios often indicate expectations of higher future growth, whereas lower P/E ratios may suggest undervaluation or limited growth prospects.

Types of P/E Multiples

• Trailing P/E: Based on earnings over the previous 12 months.
• Forward P/E: Based on projected future earnings, typically one year ahead.

Advantages of the P/E Ratio

• Simplicity and ease of calculation.
• Widely recognised by the investment community.
• Useful when comparing companies with similar capital structures.

Limitations of P/E

• Only applicable to profitable companies—negative earnings render the ratio meaningless.
• Can be distorted by accounting choices (e.g. depreciation schedules, tax strategies).
• Fails to consider differences in leverage or capital expenses across firms.

Because of these challenges, P/E is often combined with other metrics to gain a fuller perspective. While it is highly relevant for equity valuations, its dependence on net income highlights its sensitivity to non-operational factors such as interest expenses or tax rates.

An exceptionally high or low P/E could signal operational or cyclical distortions. As such, it is imperative to evaluate the quality and sustainability of earnings and to compare the P/E metric across an appropriately chosen peer group.

What Is the EV/EBITDA Ratio?

Enterprise Value to EBITDA (EV/EBITDA) is a popular valuation multiple used to assess a business’s overall value relative to its operational earnings. Unlike the P/E ratio—which focuses on equity value—EV/EBITDA provides a more comprehensive view by incorporating both debt and equity.

It is calculated as:

EV/EBITDA = (Market Capitalisation + Net Debt) ÷ EBITDA

Advantages of Using EV/EBITDA

• Capital Structure Neutral: It facilitates comparison between firms with varying capital structures, as it evaluates operating performance independent of financing decisions.
• Reflects Operating Performance: EBITDA focuses on core operations by excluding interest, taxes, and non-cash expenses like depreciation and amortisation.
• Useful for M&A: Investors and acquirers often use EV/EBITDA to assess takeover value because it reflects the entire firm's value, not just equity.

Limitations of EV/EBITDA

• EBITDA may overstate cash flow by omitting capital expenditure needs.
• Not suitable for businesses with significant asset depreciation or amortisation variations.
• Enterprise Value assumptions depend on accurate debt and cash metrics, which can fluctuate notably.

EV/EBITDA vs. P/E: A Comparative Summary

While both P/E and EV/EBITDA serve as valuation tools, they provide different lenses:

• P/E: Focuses on earnings available to equity holders and is affected by capital structure.
• EV/EBITDA: Neutral to debt/equity mix and focuses purely on operational profitability.

Industry Considerations

EV/EBITDA is particularly preferred in sectors such as telecommunications, industrials, and energy—where capital structures and depreciation patterns vary considerably. It enables a cleaner comparison of core earnings across firms, especially when assessing acquisition targets or leveraged environments.

As a best practice, analysts rely on both multiples, along with others such as EV/EBIT, Price-to-Sales, and Price-to-Book ratios, to arrive at a well-rounded view of valuation. The context, quality of data, and nature of the industry largely influence which ratio provides more actionable insight.