Question

Define and discuss the advantages and disadvantages of the method of comparables.

Answer 1

The comparables method is a method that applies ratios (such as price-to-earning ratio, price-to-sales ratio) from an industry, peer group or similar companies for the estimation of the equity value of a company. The concept that prevails behind the comparable method is the lay of one price, that means the similar assets must sell at a similar price

Advantages:

-- It is simple to understand and apply

-- It is based on fewer assumptions than the DCF

-- It captures the current market's mood in a better way

Disadvantages:

-- It is difficult to search comparables with identical, or at least similar, drivers of revenue.

-- The assumption that market accurately values the similar companies or peer group is unrealistic

-- The choice of multiples becomes subjective sometimes.