Unlocking the Secrets of Peer Comparison: How Your Business Stacks Up Against The Industry 

Valuing a privately held company uses three approaches to value; Cost Approach, Market Approach, and Income Approach. The market approach is calculated using peer comparison transactions of other similar companies in the same or similar industry sectors and is based on the Principle of Substitution; This principle presumes that a prudent buyer will pay no more for a cash flow-generating asset than the price paid for a similar and equally desirable asset. The importance of this approach is that it provides the ability to determine whether a subject company compares favorably or unfavorably to other similar companies in its industry sector. Using industry average metrics as a benchmark, more favorable comparisons allow for a more aggressive approach to value. The concept here is that if all things are equal and one company is outperforming the market average, it can be seen as more valuable. Of course, it holds true for the opposite as well where underperforming companies against the average can be seen as less valuable.

As part of the process of comparing one company to others, the most commonly used methods of comparison involve financial performance and often focus on the comparison of what each business sold for (Price) and the level of cash flow (Earnings) that the company was generating at the time of sale, otherwise known as price-to-earnings multiples (P/E Ratios). There are 3 common P/E Ratios; P/R (Price to Revenue), P/EBITDA (Price to EBITDA), and P/DE (Price to Discretionary Earnings). P/R multiples are usually best used to compare service-based businesses where there are little to no assets and cash flow margins are above 40% of revenue (high-profit companies). P/EBITDA and P/DE are cash flow multiples where the level of cash flow dictates which one to use. EBITDA for larger companies and DE for smaller / Main Street Businesses.

The objective of the peer comparison is to stack the subject company up against the other companies used in the sample comparison and then find out where the subject company fits within that comparison. You start with the baseline (Mean or Median Average P/E Ratio) then you move above or below the baseline depending on how the subject company compares. For example, if the subject company compares favorably in revenue and cash flow, you may determine that the P/E multiple you select in your comparative analysis should be above the industry average and vice versa. While revenue size may be a more attractive benchmark, revenue does not drive value, cash flow does and should be a more significant factor in how you compare other companies to your subject company. The ultimate objective is to find a supportable P/E Ratio based on facts and reasonable assumptions.

Why Peer Comparison Matters 

Peer comparison is important because it provides data to support a value conclusion based on published market data. The primary strength of peer comparison is the data itself because it’s based on other similar companies that have been acquired. It allows the comparison of financial performance, and how that performance translated into value. While the Market Approach may be one of three approaches in valuing a privately held company, in certain instances when the data is strong, it could be solely used as the basis of value.

The primary weakness of peer comparison is also the data. Because privately held company transactions are not required to be reported, many published databases of private transactions can be inconsistent and inaccurate. So it’s important to be able to understand the data, the source of the data, and the details included in each transaction you are using as a comparison.

When it comes to internal or management planning, peer comparison is a great way to benchmark value to the market and is used as the basis of setting goals for future exit. Every industry has different P/E ratios so understanding those ratios is a great starting point for planning. Once you know the starting point, you are better informed on how to strategically plan for growth, and how to maximize that growth into value.

Identifying Your Peer Group 

When it comes to comparable transactions it’s important to make sure you start by using the right industry as the basis of your comparison. While certain circumstances may allow for a multi-industry peer comparison, it’s always best to try to find a direct match first. The reason? Most businesses that operate within the same industry also operate with the same or similar financial structure. The more similar the financial structure, the better the comparison. It’s also important to pay attention to the size of the companies included in your comparison. Companies that generate $100 million in revenue are not comparable to companies that generate $5 million in revenue. Sometimes geographic location can influence value more often than not. However, it’s not a significant factor in comparison.

Determining the companies to include in your comparison sometimes can be a challenge, especially if you are looking for competitors. In a perfect world, it would be nice to know who the companies in your peer comparison are. Unfortunately, private transaction databases don’t include the company's name, only its location. Don’t let that deter you - as long as you know that they are in the same or similar industry, and you can see the basic financial structure of the company, you have ample data for comparison.

Key Metrics for Peer Comparison 

As part of your comparative analysis, you are looking for the following base metrics:

• Industry Sector
• Date of Sale
• Assets / Liabilities That Transferred in Sale
• Revenue
• Earnings (EBITDA / Discretionary Earnings)
• EBITDA % of Revenue
• DE % of Revenue

These metrics will provide a solid comparison to your subject company in all primary areas of performance. This should allow you to rank your subject company somewhere between high and low when compared to the companies in your analysis.

Gathering Comparative Data 

There are only a few commonly used private company transaction databases available, so it’s important to understand not only the source of the transaction data, but also some level of detail behind each transaction as well - details are important for an accurate comparison. As part of your analysis, you also want to make sure that you incorporate a review of industry and economic reports as well as any other types of publications that provide common size analysis (industry reports that provide average income statements and balance sheet ratios).

Your comparative analysis should start with transactions that are more recent because market trends can fluctuate from time to time over various economic cycles. With that said, the sale of privately held companies does not yield drastic swings in P/E ratios over long periods of time. The reason is that privately held companies come with an inherent amount of risk. Therefore, P/E ratios will cap out at a certain level.

Analyzing Comparative Data 

When analyzing and interpreting comparative data for private company transactions, it's essential to approach the process with a comprehensive understanding of the market landscape and the specific factors influencing each transaction. Begin by identifying comparable transactions that closely resemble the subject company in terms of industry, size, geographic location, and other relevant characteristics. Next, begin scrutinizing factors such as deal structure, financial metrics, and market conditions. Pay close attention to any unique aspects or outliers that could skew the data and adjust your analysis accordingly. Additionally, consider the timing of each transaction relative to economic trends and industry cycles to gauge how relevant the transaction is at that time. By using this contextual framework, you can derive meaningful insights into the value of a company.

Utilizing various analysis techniques such as ratio analysis, trend analysis, and benchmarking can provide valuable insights into a business's performance relative to its peers. Here are some common areas of consideration. 

1. Ratio Analysis: Ratio analysis involves examining key financial ratios to evaluate various aspects of a company's performance, liquidity, profitability, and solvency. Common ratios include:

• Profitability Ratios: These ratios measure the company's ability to generate profits relative to its revenue, assets, or equity. Examples include gross profit margin, operating profit margin, and return on assets (ROA).
• Liquidity Ratios: Liquidity ratios assess a company's ability to meet its short-term financial obligations. Examples include the current ratio and quick ratio.
• Solvency Ratios: Solvency ratios gauge the company's long-term financial stability and ability to meet its long-term debt obligations. Examples include the debt-to-equity ratio and interest coverage ratio.

2. Trend Analysis: Trend analysis involves examining the company's financial data over multiple periods to identify patterns and trends. By analyzing trends in revenue, expenses, profitability, and other key metrics, you can assess the company's performance trajectory and identify areas of strength or weakness.

3. Benchmarking: Benchmarking involves comparing the company's performance metrics to those of its industry peers. This allows you to assess how the company stacks up against its peers in terms of financial performance, operational efficiency, and other key indicators. Benchmarking can help identify areas where the company is performing well and areas where it may need improvement.

Identifying Strengths and Weaknesses with Peer Comparison 

Once you've conducted a peer comparison analysis you can use that data to identify a business's strengths and weaknesses. These areas are going to help dial in risk factors that will move the subject up or down against the market average. The risk impacts the P/E Multiple.

1. Focus on Outliers: Identify areas where the business significantly outperforms or underperforms its peers. These outliers can highlight specific strengths or weaknesses that may warrant further investigationnor even lead to the elimination of transactions from your analysis.
2. Compare Key Metrics: Compare the business's performance across key financial and operational metrics to those of its peers. Look for areas where the business excels as well as areas where it lags.
3. Industry Benchmarks: Identify areas where the business falls short of industry norms and consider strategies for improvement.
4. Qualitative Factors: Consider qualitative factors such as brand reputation, customer satisfaction, product innovation, and management expertise. These factors may not be captured in financial metrics but can significantly impact a business's overall performance and marketability.

By systematically analyzing the findings of the peer comparison and applying these strategies, you can determine where in the market landscape the subject company falls in terms of risk and P/E Multiples. Favorable findings move above the market average and vice versa.

Benchmarking Best Practices 

Markets and industries are constantly evolving due to changes in technology, consumer preferences, regulatory environments, and competitive dynamics. Continuous benchmarking allows you to stay informed about emerging trends and new developments within the industry. By monitoring the performance of industry peers you can identify shifts in the marketability of an industry and set expectations accordingly. 

Don't let the complexities of business valuation hold you back. With PeerComps by your side, you can confidently assess your business's worth and make informed decisions for its future. Say goodbye to data dilemmas and hello to precision and clarity in business valuation. Sign up for PeerComps today and unlock the true value of your business.