The method of comparables

CFA Level II Equities
#1

Maybe my question will seem rather simple, but I can’t understand the following.

The method of comparables values a stock based on average price multiple of the stock of similar companies which is based on the Law of one price (similar assets should sell at comparable price multiples). Ok, but what if my company in reality is fair priced, but other similar companies are over/undervalued. For example, my company have trailing P/E = 10 while average of comparable companies is 12. Using this method I must conclude that my company is undervalued, but how I can be assured that comparable companies are not overvalued?

Thanks a lot in advance!

#2

In a snapshot: This method assumes that market always value correct (market value = fair value).

Best, Oscar

#3

Hmm, taking into consideration that market is not efficient in practice such model seems to me not appropriate for determining is stock over/undervalued of fair priced

#4

For that, you need to base your valuation on future cash-flows, i.e. model a DCF.

#5

So you are agree with irrelevancy of such model in a real life? :slight_smile:

#6

It depends, like often in finance what you believe in. This is what finance is all about!

In any case multiple valuation often serves as a plausibility check to a DCF model and vice versa.

Regards,

Oscar

#7

Ok, thanks for your explanation.

#8

great question. the way I look at it is to take a look at the historical relative comparison. If historically, it’s always been undervalued by 2 or is it based on recent developments that the subject company is undervalued by 2.