Optimal Equity Valuation Using Multiples: The Number of Comparable Firms

31 Pages Posted: 23 Sep 2008

Date Written: September 23, 2008

Abstract

We examine how the accuracy of a multiples-based valuation changes as the number of comparable firms used to estimate the valuation multiple increases. Our research is motivated by a contrast between the approach followed by practitioners, who typically use a small number of closely comparable firms, and the academic literature which often uses all firms in an industry. Using a simple selection rule based on growth rates, we find that using ten closely comparable firms is as accurate on average as using the entire cross-section of firms in an industry. Using five comparable firms is slightly less accurate. However, the loss of accuracy from using five comparable firms rather than ten firms or the entire industry is not great. The relative accuracy of a valuation based on five comparables does not vary in a predicable way across industries, except that it is generally better to use a small number rather than all firms in an industry with a large number of members. However, the relative accuracy of a valuation based on a small number of comparables does depend heavily on the similarity of the comparable firms to the target firm. If there are firms in the same industry with growth rates close to that of the target firm, then it is better to use a small number of comparables. Adding more firms simply adds noise, on average.

Keywords: Equity valuation, valuation, multiples valuation

JEL Classification: G11, G12, G24, D81

Suggested Citation

Cooper, Ian Anthony and Cordeiro, Leonardo, Optimal Equity Valuation Using Multiples: The Number of Comparable Firms (September 23, 2008). Available at SSRN: https://ssrn.com/abstract=1272349 or http://dx.doi.org/10.2139/ssrn.1272349

Ian Anthony Cooper (Contact Author)

London Business School ( email )

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No contact information is available for Leonardo Cordeiro

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