Relative valuation
Also written Selling price-based approach · Comparables valuation
Valuing an asset from the prices of comparable assets rather than from its own cash flows — quick, intuitive, and dependent on whoever set those comparable prices being right.
In plain language
The workbook makes the point with an apartment. Before you negotiate, you find what similar flats in the same locality sold for. You are not computing the present value of the rent the flat will earn for thirty years; you are asking what the market pays for a flat like this one.
Relative valuation does the same for a business. Price it against what the market pays for comparable companies, using multiples such as P/E, P/B and EV/EBITDA. It will not tell you what a company is worth. It will tell you whether it is cheap or expensive relative to its peers, which is a different and more modest claim.
How it works
The workbook separates the two sources of comparables.
Trading multiples come from the stock market — what comparable listed companies trade at today.
Transaction multiples come from deals that have actually completed. The workbook rates these more authentic, because they represent the willingness of a real buyer to pay that value for the whole asset, rather than the price of a marginal share.
The method is fast and needs few assumptions, but it carries the market's mood — optimistic or pessimistic — straight into the answer. The workbook's discipline is to look at the maximum, minimum and average rather than one number, and to compare against the industry rather than a single peer. It warns specifically about averages: in a fragmented industry a few outliers pull the mean well above where most firms sit, so check the median as well as the mean before taking a call.
And it insists on companion variables: a low multiple may be a fundamental weakness rather than a bargain. P/E belongs with growth and ROE; EV/EBITDA belongs with return on investment.
A worked example
A speciality chemicals company: FY26 estimated EBITDA Rs 420 crore, net debt Rs 560 crore, 9 crore shares.
Five listed peers trade at EV/EBITDA of 11.2×, 9.8×, 14.6×, 10.1× and 9.5×.
Mean = 55.2 ÷ 5 = 11.04× Median = 10.1×
At the mean:
EV = 420 × 11.04 = Rs 4,636.8 crore
Equity = 4,636.8 − 560 = Rs 4,076.8 crore
Per share = 4,076.8 ÷ 9 = Rs 453
At the median:
EV = 420 × 10.1 = Rs 4,242 crore
Equity = 4,242 − 560 = Rs 3,682 crore
Per share = 3,682 ÷ 9 = Rs 409
The single 14.6× outlier is worth Rs 44 a share, nearly 10% of the valuation. That is the workbook's caution about fragmented industries and outlier players, in rupees.
Now suppose a competitor was acquired last quarter at 13× EBITDA. That transaction multiple values the company at Rs 5,460 crore of EV and Rs 544 a share — a third answer, and on the workbook's reading the most authentic of the three, because someone actually paid it.
Why NISM asks about it
Chapter 10 introduces relative valuation as the third approach in section 10.4, develops it in 10.6, and splits trading from transaction multiples in 10.9. Expect a question on which of the three approaches — cost based, cash flow based, selling price based — a given description belongs to, and on why transaction multiples are considered more authentic than trading multiples.
Common exam traps
- It is a relative answer, not an absolute one. If the entire sector is overpriced, every member of it looks fairly valued.
- Match the numerator to the denominator. P/E and PEG are equity multiples; EV/EBITDA, EV/EBIT and EV/Sales are whole-firm multiples. Pairing market capitalisation with EBITDA is the classic mismatch.
- Check the median, not just the mean. The workbook warns that outliers in a fragmented industry pull the average up while most firms sit near the median.
- A low multiple is not automatically cheap. Use the companion variables — P/E against growth and ROE, EV/EBITDA against ROI — to see whether the discount reflects a real weakness.
- Transaction multiples usually include a control premium that a minority shareholder in the listed market will never be paid.
- Cost based valuation is a third approach, not part of this one. It values an asset at what it would cost to create, and the workbook says it is generally unsuitable for financial investors.
Check yourself
1.Besides the perpetual growth model, what other method does the workbook allow for calculating a terminal value?
- a)Adding up the undiscounted cash flows of the high growth phase
- b)Multiplying EBITDA (or EBIT) at the end of the high growth period by an appropriate EV/EBITDA (or EV/EBIT) multiple taken from comparable firms
- c)Using the book value of equity at the end of the forecast period
- d)Multiplying the final year's dividend by the cost of equity
Show the answer
Answer: (b) Multiplying EBITDA (or EBIT) at the end of the high growth period by an appropriate EV/EBITDA (or EV/EBIT) multiple taken from comparable firms
The workbook's alternative: "terminal value can also be calculated by taking into consideration expected sale value of the business at the end of high growth phase. This is typically done by multiplying EBITDA (or EBIT) at the end of the high growth period by the appropriate EV/EBITDA (or EV/EBIT) multiple. The multiple is decided based on that of comparable firms."
That links the two halves of the chapter. The DCF borrows a relative valuation multiple for its final stage.
Whatever method is used, one rule still applies: "The terminal value is added to the cash flows for the growth or projection period, and then discounted to the present value."
Why the others are wrong:
- Option A adds up the forecast years. It says nothing about value beyond them, and it ignores discounting completely.
- Option C uses a historical-cost balance sheet figure. That is not a sale value, and the workbook warns that for capital-intensive firms book values "often do not reflect the fair value".
- Option D is not a valuation formula. Multiplying a cash flow by a rate gives a smaller cash flow, not a capital value.
2.An analyst can compare a company with stock market prices of peers (trading multiples) or with recent deals for similar businesses (transaction multiples). What does the workbook say about the two?
- a)Trading multiples are more authentic because they are observed every day
- b)The two are identical by definition and interchangeable
- c)Transaction multiples are more relevant, because they show some entity's willingness to acquire the asset at that value
- d)Transaction multiples should be avoided, as they are not observable in the market
Show the answer
Answer: (c) Transaction multiples are more relevant, because they show some entity's willingness to acquire the asset at that value
The workbook: "These comparables may be coming from the Stock market (called Trading Multiples) or from the other similar transactions (called Transaction Multiples) which have consummated in the recent past. Transaction multiples are more relevant because they represent the willingness of some entities to acquire the asset at that specific value, and hence relatively more authentic compared to the prices at which they are traded."
Why the others are wrong:
- Option A reverses the ranking. Trading every day does not make a price more authentic. The workbook also warns that relative valuation "reflects current market mood, which may be quite optimistic or pessimistic."
- Option B. One comes from market trading and the other from completed deals.
- Option D. Completed transactions are exactly what makes these multiples useful.
The workbook's advice on the market-mood problem is practical: "it is always good to use parameters like maximum, minimum, average etc. while using relative valuations." Its everyday analogy is buying an apartment, where you check what comparable flats in the locality have sold for.
Where this is taught
- Series XIX-A · Chapter 11: Valuationintroduced here
- Series XV · Chapter 10: Valuation Principlesintroduced here
- Series XIX-C · Chapter 14: Valuationintroduced here
- Series XIX-E · Chapter 12: Valuationintroduced here
- Series XXI-A · Chapter 3: Investing in Stocksintroduced here
Related terms
- Discounted Cash FlowA valuation method that estimates the cash a business will generate in future years and converts each year back to what it is worth today.
- Earnings yieldEarnings per share divided by the current market price — the reciprocal of the P/E ratio, expressed as a percentage so that equity can be set directly against a bond yield.
- Enterprise ValueWhat it would cost to buy the whole business — market capitalisation plus debt, less cash — as opposed to market capitalisation, which buys only the equity.
- Intrinsic valueWhat an asset is actually worth — the present value of the cash it will generate over its remaining life, as against whatever price the market is quoting today.
- PEG ratioThe price to earnings ratio divided by the expected earnings growth rate — Peter Lynch's way of asking whether a high P/E is justified by the growth behind it.
- Price to Book ValueShare price divided by book value per share — how many times the accounting net worth of a company the market is willing to pay.
- Sum-of-the-partsValuing a conglomerate by valuing each business separately on its own appropriate multiple and adding the results, instead of applying one blended multiple to the group.
- Price-to-Sales ratioShare price divided by annual net sales per share (or market capitalisation divided by annual net sales) — what investors pay for each rupee of a company's revenue.
- Adjusted book valueFair value of a company's assets minus the fair value of its liabilities, factoring in off-balance-sheet items — used to value non-banking financial companies (NBFCs).
- Companion variablesThe fundamental metric an analyst must read alongside a valuation multiple — such as growth with P/E, or ROIC with EV/EBITDA — to judge whether a low multiple is cheap or a warning.
- Market approachValuing a business from what the market pays for comparable businesses, using earnings and market multiples rather than the company's own projected cash flows.
- Cost based valuationValuing an asset by what it would cost to build it from scratch today, rather than by its cash flows or the price of comparable assets — mainly used by strategic, not financial, investors.
- GICSThe Global Industry Classification Standard — a four-tier system widely used by global investors, with 11 sectors, 25 industry groups, 74 industries and 163 sub-industries.
- Embedded valueFor a life insurer, the present value of the expected net future cash flow — adjusted for probability — from the policies currently in force, used as the base of a Price/Embedded value multiple.
- Book Value approachThe first of the three asset-based valuation methods: value the company at the historical carrying cost of its assets and liabilities, giving a book value per share treated as the floor price.
- Equity ValueThe value of 100% of a company's shares — what belongs to equity shareholders after debt and preference capital are deducted from enterprise value. For a listed company, its market capitalisation.
- P/E ratioShare price divided by earnings per share — how many rupees investors pay for each rupee of earnings. The most common relative valuation measure.