Relative valuation by multiples

Where DCF builds value from the ground up, relative valuation asks a simpler question: what are similar companies worth, and what does that imply for this one? It is faster than a DCF and grounded in real market prices.

The method

1. Pick a group of genuinely comparable companies — same industry, similar size and growth.
2. Compute a valuation multiple (P/E, EV/EBITDA) for each.
3. Take the median of the peer group.
4. Apply it to the target company's metric.

A worked example

You are valuing a company that earned net income of 150. Three close peers trade at P/E ratios of 18, 20 and 22, so the median peer P/E is 20.

Implied value = Net income x peer P/E
              = 150 x 20 = 3,000

If the company has 100 shares, the implied price is 3,000 / 100 = 30.00 per share. Compare that to the actual price to judge cheap or expensive relative to its peers.

Strengths and traps

• Strength: fast, intuitive, and anchored in what investors actually pay today.
• Trap — the whole sector can be mispriced. Relative valuation only tells you a company is cheap compared to its peers; if the entire industry is in a bubble, "cheap relative to peers" still means overvalued in absolute terms.
• Trap — false comparables. Companies that look similar but differ in growth, margins or risk should not share a multiple. The quality of the result depends entirely on the quality of the peer group.

Best practice is to use relative valuation and DCF together — when both point the same way, your conviction is far stronger.