How to compare stocks using relative valuation

Compare prices on a common basis

Relative valuation compares how similar businesses are priced using a common measure, such as earnings or revenue. A share price alone cannot do that: the number of shares differs across companies. Aswath Damodaran’s introduction to relative valuation explains why comparable fundamentals and consistent multiples matter.

A lower multiple is not proof of a bargain. Differences in growth, risk and cash generation can explain different prices. Relative valuation also does not establish an absolute fair value: the whole comparison group may be expensive or inexpensive.

Write down the comparison rules first

For your research worksheet, choose companies with business models you can explain side by side. Record the period used by each metric. LTM refers to the last twelve months; NTM refers to the next twelve months and therefore uses estimates. Do not silently mix historical results and forecasts.

Use the worked example below as an arithmetic check, not as a target multiple. Ask why the gap exists before drawing a conclusion. For each company, make a note of the most important difference you have not controlled for.

• Are the businesses meaningfully comparable?
• Are the periods and metric definitions consistent?
• Are forecasts current, and what could make them wrong?
• Does the apparent discount reflect a risk I have not examined?

What Polydesk’s valuation ranking measures

The current method uses six metrics: LTM and NTM enterprise value/revenue, LTM and NTM enterprise value/EBITDA, forward price/earnings, and NTM market capitalization/free cash flow. Lower multiples receive higher relative scores. The default weights are approximately equal, and the settings can change their importance.

For this strategy, a company must have a finite, positive value for every enabled metric. Missing, zero or negative values can exclude a company from the ranking; they do not mean the business has no investment merit. Turning off a metric changes that eligibility requirement as well as the scoring inputs.

Each enabled metric is ranked among eligible companies, then combined using its weight. The result is a relative research score, not a percentage upside estimate or a probability of success. It does not automatically adjust for all differences in business quality, risk or accounting.

Use the ranking to choose the next question

Open the factors behind a result and identify which metric contributes most. Check its source period against company disclosures. Then record an alternative explanation for the apparent cheapness, such as uncertainty in the forecast, and the evidence needed to assess it.

A practical stopping point for this session is a short note explaining both the valuation gap and the unanswered question. That is more informative than a list of companies ordered from low to high with no context.

Worked example

A has the lowest multiple in this example. Nothing here establishes which company is the best investment; the full Polydesk method uses multiple eligible inputs.