Trading Comps

Trading comps value a company by asking what the market is paying, right now, for a share of a similar company.

The workbook's definition is specific: trading comps are the market based multiples, and the two it names are the P/E ratio and the Price to Book Value ratio. Both put a market price in the numerator, which is what makes them "trading" multiples: they are read off a live screen.

That also sets their limit. A company with no market price has no trading comp of its own — which is the position of every investee company a Category I or II AIF holds.

The P/E ratio is the most widely used market-related multiple in valuation, and the workbook describes it as a useful metric for gauging a company's value as a multiple of its current earning capacity. It can also be used to compare unlisted companies in the alternative space with their listed peers, to know the range at which they are being valued.

The P/BV ratio compares market value to networth. In listed companies, a market value of 4 to 5 times book value is considered a healthy valuation; in unlisted companies, a DCF value can be cross-checked against the book value multiple.

For unlisted companies the workbook says trading comps are quite unsuitable, and at best the current market multiples of listed surrogates may be used. That difficulty is exactly why relative valuation developed firm value multiples — EV-based measures that determine value without reference to a market price at all.

One structural warning applies to every multiple in the chapter: relative valuation determines the enterprise value, so outstanding debt has to come off to reach equity value.

P/E ratio   = Market price per share ÷ Earnings per share
P/BV ratio  = Market value ÷ Networth

And running it backwards, as Illustration 11.8 does:

Market price = P/E × EPS

Illustration 11.8 first. Alpha Ltd: after-tax profit Rs 100 lakh, paid-up capital Rs 200 lakh in 20 lakh shares of Rs 10, trading at a P/E of 32.

EPS          = 1,00,00,000 ÷ 20,00,000 = Rs 5
Market price = 32 × 5 = Rs 160 per share

Now a Category II AIF valuing an unlisted logistics company with PAT of Rs 96 crore on 12 crore shares — EPS Rs 8. Its three closest listed peers trade at P/E multiples of 28, 34 and 31:

The Rs 74.40 a share knocked off — Rs 893 crore in total — is the entire difference between a quoted share and one that cannot be sold on a Tuesday morning. If the company files for an IPO and the manager believes the exit is imminent, that discount narrows and the carrying value rises without the business changing at all.

Illustration 11.7 shows where the other trading comp gives out. A start-up funds itself with equity at a premium, books the premium to reserves, then burns through it. Accumulated losses wipe out the reserves and can erode the nominal value of the subscribed capital, so book value goes negative — and P/BV cannot be used at all.

Chapter 11 (Valuation), section 11.7 and sub-sections 11.7.2 and 11.7.3, with Illustrations 11.7 and 11.8. Expect a P/E computation of the Illustration 11.8 shape, and a conceptual question on why trading comps are unsuitable for unlisted companies — no market price validation, so you are reduced to listed surrogates.

• Learn the workbook's own mapping. It calls the P/E and P/BV multiples "Trading Comps" and the EV/EBITDA and EV/Sales multiples "Deal Comps". Market practice outside the workbook often uses "trading comps" for any multiple derived from listed peers, EV multiples included. Answer the exam on the workbook's mapping.
• P/BV breaks on negative book value, which is normal for a loss-making start-up. Illustration 11.7 exists to make this point.
• Trading comps need a market price. For an unlisted company you are borrowing a listed surrogate's multiple, and the workbook calls that at best a second choice.
• Apply an illiquidity discount when carrying a listed multiple across to unlisted stock — reduced if an exit is imminent, per the IPEV discussion in the same chapter.
• The "4 to 5 times book value is healthy" observation is about listed companies. Do not apply it as a rule to an unlisted investee.
• P/E pairs equity price with equity earnings. Do not mix it with enterprise value.