Ideally, there are direct competitors and pure plays, meaning they only focus on that one product/service. You can also include companies that offer similar services. In our example compset below, most are internet/tech companies. But there is a sub-segment of pure internet companies if you remove Apple and RIMM.

You can also segment the list based on size or other outliers.

In my experience, the ideal list size is 7-10 companies.

Price Metrics

A typical compset will first include the stock price, equity value, and total enterprise value. The stock price is pulled directly from any stock quote service; the others are derived from the stock price. Both equity value and enterprise value are also easily pulled from most stock quote.

Multiples

The common multipes included in a compset are the Revenue Multiple, EBITDA Multiple, and P/E Multiple. These are a simple calculation of the total enterprise value devided by the relevant operating metric. There are several variations on the timing of the metrics including current year, next year, and last twelve months (LTM).

You can also include more industry specific metrics. Real Estate would look at rental rates while a product company would focus on gross margin.

Industry Operating Metrics

Key operating metrics are also included so that the company can be compared to the industry as a whole to make the case for a higher or lower valuation.

They typical items included are:

* Cash and Debt Leverage makes a big difference in how a company approaches financial decisions. Less debt means more cash flow available to the shareholders, therefore a high price.

* Revenue Size does matter. A billion dollar company has scale and other effiencies that a hundred million dollar company wont have.

* Revenue Growth The higher the growth rate, the higher the price.

* Margin (Gross, EBITDA) Margin is usually tied to the business model. A services companys margin is different from that of a product company. Higher margin means more income which translates to a higher price.

Like other aspects of valuation, putting together the numbers is a science. They are driven by logic and calcuations and is straight forward.

The art is in how you tell the story of the target.

If you are the buyer, you want to use the numbers to drive a lower price. Using the multiples and metrics above, you would develop reasoning to support your lower price. For example, a smaller company compared to the industry typically has lower multiples. You can segement your compset and see if there is a distinct difference in the multiples. If the company has lower margins compared to the industry, the multiples should be lower. Use the numbers to prove your case.

Public valuations dont translate to private businesses. So, you apply a discount of varying degrees to the multiple before valuing the business. There are two common reasons to discount the multiple, size and liquidity. Liquidity is straight forward. As a private company, you cant just buy and sell the shares- youre locked up for a long period and that lack of liquidity typically translates to a discount of 15%-25%. Size and economies of scale is the other reason for discounting. Ive seen it applied anywhere from 5% to 50%. Again this is part of the art of valuation and making the numbers work for you.