Relative Valuation
Relative valuation is a method of estimating the value of a company by comparing its valuation multiples—such as PE, EV/EBITDA, or Price-to-Book—to those of peer companies or sector averages, based on the principle that similar businesses should trade at similar prices relative to their earnings or assets.
Unlike DCF, which is an absolute valuation method that attempts to calculate intrinsic value from first principles, relative valuation is inherently comparative. The underlying assumption is that the market correctly prices comparable companies on average, and any deviation from this average either represents mispricing or reflects genuine fundamental differences that need to be explained.
The most commonly used multiples in India include Price-to-Earnings (PE), EV/EBITDA, Price-to-Book (PB), Price-to-Sales (PS), and EV/Revenue. Each is suited to different situations. PE is most relevant for profitable, mature companies. EV/EBITDA is used for capital-intensive businesses where depreciation and financial structure vary widely across peers. PB is standard for banks and financial institutions. PS or EV/Revenue is used for pre-profit companies or those in early growth phases.
The key challenge in relative valuation is selecting a truly comparable peer group. For Indian companies, this is complicated by the conglomerate structure of many large groups (making pure-play comparisons difficult), the difference in size between domestic and global peers, and differences in accounting standards, growth expectations, and market liquidity premiums.
Relative valuation can be misleading when the entire peer group is mispriced—the so-called benchmark fallacy. During the 2021 new-age tech IPO wave in India, many companies argued their valuations were reasonable relative to global peers, all of which were trading at historically elevated multiples. When sentiment reversed, the entire group de-rated simultaneously.
Best practice is to combine relative and absolute valuation. A stock that looks cheap on relative valuation and also has a DCF suggesting upside provides a stronger thesis than one that passes only one test. Analysts also distinguish between forward multiples (based on projected earnings) and trailing multiples (based on past 12 months' earnings), with forward multiples generally more relevant for valuation purposes.