Investment banking analysts use three methods to estimate the value of a company: DCF Analysis, Comparable Company Analysis, and Precedent Transactions Analysis. The Precedent Transactions Analysis is a simple tool that gives you an idea of the value. However, more complex analysis methods may be needed when more accuracy is required. Precedent Transactions Analysis remains essential.
Precedent Transactions Analysis is even more helpful in some situations. For example, it is used to evaluate the market demand when purchasing a business in a particular industry.
This article will give you an overview of this method and a step-by-step guide on how to value your company using the Precedent Transactions Analysis.
What is Precedent Transaction Analysis?
The precedent transaction analysis is used to value a company by comparing the prices paid in the past for similar companies. This method is used to determine the value of an individual share in the case of an acquisition. This analysis uses publicly-available information to determine multiples and premiums paid by others for publicly-traded firms similar to yours.
In the process of precedent analysis, the most relevant transactions are identified by comparing companies with similar financial characteristics in the same sector and transaction size. The relevance of a particular transaction is based on the date it was completed.
How do Precedent Transaction Analyses Work?
The precedent transaction analysis uses publicly available data to estimate multiples and premiums other investors have paid for publicly traded companies. The analysis examines the types of investors who have bought similar companies in similar circumstances before and whether those companies are likely to acquire another company soon.
The most important part of a precedent transaction analysis is identifying the most relevant transactions. The companies chosen should have similar financial characteristics and be in the same sector. The transaction size should be comparable to what the target company is considering.
Precedent Transaction Analysis Process
The process is multi-step:
1. Search for Relevant Transactions
First, you should research recent transactions in the industry. The criteria include industry classification, the type of company (public or privately held), financial metrics, geographic location, company size, product range, and information about buyers (competitors, private equity, etc.). The size of the transaction and its value are among the factors to be considered.
2. Analyze the Transactions
After the above transactions have been recorded, analysts must narrow their scope and remove data irrelevant to the current transaction.
3. Calculate the Range of Multiples for Valuation
After the two previous steps, you must calculate the average of the multiples (or a range). This is the sweet spot for financial experts who deal with formulas such as EV/EBITDA and EV/revenue.
4. Use the Following Valuations
Once the ranges of multiples derived from the data in Step 1 above have been determined, these ratios are applied to a transaction. Again, this is the financial experts’ responsibility in marketing.
5. Record the Results and Graph Them
These evaluations typically include a comparable company analysis, precedent transaction analysis, ability to pay, and, if it’s based on NASDAQ, a 52-week highs and lows metric. These valuations include comparable company analysis DCF Analysis and ability-to-deliver analysis. They also have a 52-week low/high metric if it’s a public company.
Benefits of Precedent Transaction Analysis
Investors should incorporate the use of precedent transactions into their investment strategy.
Here are some of the most significant benefits.
1. Sets the Benchmark for Valuation
To determine the value of something, you can use a precedent transaction analysis. It may not be possible to decide on an exact price for a stock, but it can give a better idea of what other people are willing to pay in a particular market. This method benefits young businesses or those who have yet to be profitable, as other valuation methods, such as the Discounted Cash Flow Model, rely on historical data to predict prices accurately.
You can use a PTA’s results to determine whether you overpay for your stocks. Compare its financial metrics with the rest of the stock market. If they are higher than usual, you should be cautious. It may indicate that the time is right to buy if it’s not.
2. A Quick and Effective Valuation Technique
In addition to the second benefit, precedent transaction analyses are a fast and efficient way to assess the value of a company without having to do much work. All the information has been gathered and made public, so you only need to give it a quick look. Precedent transactions are the best option and future of investment banking if you need more time to research properly and understand how to value a business.
3. Based on Actual Market Transactions
As the precedent analysis is based upon previous market transactions, much of your hard work has been done. You can also be assured that these valuations are accurate and done with due diligence. You can then compare the data and determine where the asset you are analyzing falls in the equation.
Conclusion
You can see that precedent transaction analysis is a handy tool for comparing businesses in the same sector. Retail investors can still use this tool to their advantage, even though its full potential is reserved for big investment banks or private equity firms looking to buy businesses.
PTA is an excellent tool to use in conjunction with other valuation methods, like DCF. This is because there can be a significant difference between your price and the value of the business if comparable companies differ significantly.
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