What criteria should I use to select comparable companies for relative valuation?

Comparable company selection is arguably the most important and most subjective step in relative valuation. Using poor comps produces misleading results regardless of how precisely you calculate the multiples.

Selection Framework (Priority Order):

1. Industry and Business Model (Most Important)

• Same SIC/GICS code is a starting point but not sufficient
• Must share similar revenue model (subscription vs. transaction, B2B vs. B2C)
• Example: Comparing a SaaS company to a hardware company just because both are 'tech' is inappropriate

2. Size and Scale

• Similar market cap or enterprise value (within 0.5x to 2.0x range)
• Size affects liquidity, analyst coverage, institutional ownership, and access to capital
• A $500M company is not comparable to a $50B company even in the same industry

3. Growth Profile

• Similar revenue and earnings growth rates (past 3 years and forward estimates)
• A company growing at 30% should not be compared to one growing at 5%
• This is why PEG attempts to normalize, but it has its own problems

4. Profitability and Margins

• Similar EBITDA margins, operating margins, and return on capital
• Margin differences signal different competitive positions, cost structures, or business mixes
• A 40%-margin software company vs. a 10%-margin hardware company will have very different multiples

5. Risk and Leverage

• Similar debt-to-equity ratios and interest coverage
• Use EV/EBITDA rather than P/E to neutralize leverage differences
• Similar beta or business cyclicality

6. Geography and Regulatory Environment

• Companies in the same jurisdiction face similar tax, labor, and regulatory burdens
• Emerging market vs. developed market companies have different risk premiums

Practical Application — Selecting Comps for Brookdale Analytics (fictional):

Brookdale is a mid-cap US SaaS company ($2B EV) with 22% revenue growth, 35% EBITDA margins.

Best comp set: Silverline + Atlas Cloud. Zenith, Nimbus, and Paragon fail on business model, geography, or size criteria.

What If No Perfect Comps Exist?

1. Use the closest available comps and acknowledge the limitations
2. Adjust multiples qualitatively for known differences (e.g., 'Brookdale deserves a 10% premium to the peer average given higher margins')
3. Use a broader peer set and apply regression analysis — regress P/E on growth, margins, and risk to get a fitted value for the target
4. Supplement with precedent transactions if available

Exam tip: CFA Level II item sets often present 4-5 potential comparables with financial data and ask you to identify which are appropriate. Eliminate candidates that fail on the most important criteria (business model first, then size and growth).

Refine your comparable analysis skills with our CFA Level II equity course.