Question

Can someone paraphrase this please?

Comparable Companies Analysis - The comparable analysis is an example of relative stock valuation. This model can be used if an investor is unable to value the company using any of the other models, or if he/she simply does'nt want to spend the time crunching the numbers. This model compares the stock's price multiples to a benchmark to determine if the stock is relatively undervalued or overvalued. The rationale for this is based on the Law of One Price, which states that two similar assets should sell for similar prices.

The reason why the comparables model can be used in almost all circumstances is due to the vast number of multiples/financial ratios that can be used, such as the price-to-earnings (P/E), price-to-book (P/B), price-to-sales (P/S), price-to-cash flow (P/CF), etc. Of these ratios, the P/E ratio is the most commonly used because it focuses on the earnings of the company, which is one of the primary drivers of an investment's value.

One can you use the P/E multiple for a comparison if the company is publicly traded since he/she need both the data :- stock price and the earnings of the company. Secondly, the company should be generating positive earnings because a comparison using a negative P/E multiple would be meaningless. Lastly, the earnings should not be too volatile, and the accounting practices used by management should not distort the reported earnings drastically.

Answer 1

Comparable companies analysis is a method of relative valuation in which companies are to be compared with related companies in In same industry and it is if the investor is not able to value the company using any of the other methods.

This valuation method is based on the principle of law of One price which indicates that the price of two securities of similar nature having the relative prices and this can be discounted using various kinds of factors like similar price to earning growth or similar price to book or similar price to cash flows and price to earning is the most common among all.

Price to earning only be compared with those shares will have positive cash flows because price to earning is only calculated if the company generating positive profit and it is to be compared with the market price of the company and the earnings should be stable in nature also because volatile earnings can lead to inappropriate valuations.