Choosing the Right Peers When Valuating Based On Comparable Company Multiples
When performing valuations based on multiples of publicly traded companies, choosing comparable peers is an often overlooked but important task.
When the valuated company is from the technology industry, the task becomes especially tricky. Technology companies operate in a complex business environment, with many layers of operation and innovation within. This means that the valuator must search through hundreds of companies to find the few comparables that are most suitable for the valuation.
But this leads to a question: Is the screening of an industry and specific sub-industry (as specified by Yahoo Finance for example) enough for finding the right comparables?
Let’s take a look at an example in order to answer this question.
In this example, the valuated technology company sells Performance Management Software as a Service (SaaS) to other companies.
Step 1 – Screening according to industry and sub-industry.
Step 2 – Finding peers with the description SaaS.
The following table shows the first three comparable companies found in AlgoValue.
As you can see, the EV/ Sales ratio range is quite high. In this case, it may suggest that the peers are not in the same field of operations.
Step 3 – Further research about the valuated company shows that it operates in the Software Performance Management segment. AlgoValue provides an appropriate response and solution for these types of scenarios: you can simply hover over the company name to open a tooltip with a detailed description of the company. In this example, we see that the only relevant peer company from the table is NewRelic, Inc.
Step 4 – Finding the right competitors. If we look at New Relic’s competitors (from the company’s financial report), there are software performance providers such as Splunk Inc. and diversified technology companies such as Oracle Corporation, that also provide SaaS for Performance Management. The following table shows the mutiples of the three comparable companies, as of 05/09/2016:
We can see here that the EV/ Sales ratio range is quite normal. Although Oracle is a huge company with diversified operations, its multiples represent the expected growth rate in the business software industry. This represents an excellent starting point for expanding the valuation benchmark based on multiples of comparable companies.
With today’s complex valuations, screening by industry and sub-industry is not sufficient for finding the right comparable. Valuators need to perform more in-depth operational research about the valuated company, especially in the technology arena. This research will eventually help the valuator add the right comparables when choosing their peers, and eliminate companies that are not relevant to the valuation.