Valuation From Comparables And

Valuation From Comparables and

Financial Ratios

A Practical Approach

You now know how to read financial statements, how to obtain cash flows from financial

statements, and how to value them. You also know that forecasting cash flows is a very

difficult task. Are there any shortcuts? Are there any good alternatives to NPV? Is there

anything else you can do with financial statements?

Surprisingly, the answer is yes. There is one alternative approach often resorted to by practitioners.

It is called "valuation by comparables," or "comps" for short. Executed correctly, comps

can give answers that are as good as those that you can obtain with a thorough NPV analysis.

In practice, sometimes the method of NPV gives a better value estimate, and sometimes the

method of comparables does.

The basic idea behind valuation by comparables is simple and best understood by analogy:

assume that you want to determine the value of 5 red marbles. If black marbles cost $2 apiece,

and if you are willing to make the assumption that red marbles are valued like black marbles,

then you can compute that the value of your 5 red marbles should be $10. It is not necessary to

forecast what value marbles will have in the future or what discount factor applies: the market

price of black marbles has already taken all this information into account.

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