Tutorial: compare two companies properly
Comparisons are only valid within an industry, and only after you have adjusted for debt.
Decide which of two rivals is the better business, and which is the better price.
How compare two companies properly works, in one picture
The same argument as the text, as a chain. Each step is what makes the next one possible.
The order matters more than the maths
Cheapness is the last question. Ask it first and you produce a list of companies the market has given up on, and it is usually right.
- 1
Only compare like with like
Compare tabA P/E of 12 in software and a P/E of 12 in mining are not the same fact. Margins, capital intensity and cyclicality differ so much between industries that cross-sector multiple comparison is close to meaningless. Stay inside the sector.
- 2
Use enterprise value, not market cap
If you buy a company you inherit its debts and you keep its cash. Two firms with the same market cap can cost wildly different amounts to actually own. Enterprise value adjusts for both, and it is what an acquirer thinks in.
Comparing market caps between a debt-free company and a leveraged one is not comparing prices.
- 3
Separate the business question from the price question
First ask which is the better business: higher and more durable returns on capital, better margin trend, less debt. Only then ask which is better value. Conflating the two is how people talk themselves into cheap rubbish.
- 4
Compare the trajectory, not the snapshot
Index both companies' revenue to 100 at the start of the period and watch the lines diverge. A snapshot tells you where they are. The trajectory tells you who is winning, which is the thing you are actually buying.
Ordinary. The market expects steady, unremarkable growth.
You can say which is the better business and which is the better price, and be comfortable that those are different answers.
Read next
Comparisons are only valid within an industry, and only after you have adjusted for debt.
1,100+ companies across 17 exchanges, filtered on any combination of moat, valuation, growth and debt.