Comparable company valuation
It is common that practitioners use multiples to find the value of the company they are interested in. When you want to analyze a company using a multiple in a comparable company analysis valuation, you should find a multiple that relates the enterprise value to a performance measure. Common performance measures are enterprise-value-to earnings before interest tax depreciation and amortization EV/EBITDA, EV/EBITA and earnings.
To be meaningful, it is important that the performance measure is proportional to value. Valuing a company solely based on peer group multiples is problematic. One has to find a group of companies with similar growth prospects, profitability and level of risk. Thus, multiple valuations (comparable company analysis) are to be seen more as a complement to the DCF (APV) and the LBO valuations than an actual assessment of the value.
Comparable company analysis (trading comps)
A multiple on its own bears little information; it is meaningful only when compared to multiples of other companies. A good comparable company has two main characteristics:
1) The comparable company has future cash flow forecasts similar to the company you are interested in
2) The risks associated with the comparable are similar to the risks of the company you are interested in
In theory, if these characteristics are present and the performance measure is proportional to value, the use of comparables can provide a more accurate measure of value than any DCF model. It will provide a more accurate measure since multiples incorporate contemporaneous market predictions of cash flows and discount rates. In practice, comparable companies will never be perfect matches. Cash flows and risks are bound to differ, products are rarely perfect substitutes, managers have different management styles, capital structures differ between firms and many other factors affect cash flows and associated risk levels.