Understanding Market Approach in Valuation

The market approach in valuation is a widely used method that determines the value of a business, asset, or security by comparing it with similar entities available in the marketplace. It relies on real-world data—such as trading multiples, recent transactions, and comparable company values—to estimate a fair market price. This approach is especially relevant in dynamic markets where real-time pricing and investor sentiment play important roles.

The market approach is a valuation method that uses market-based evidence to estimate the value of a company or asset. It examines how similar businesses or assets are priced and applies those benchmarks to the subject entity.

This method is grounded in the principle of substitution—meaning that an investor will not pay more for an asset than the cost of acquiring a similar one.

In practical terms, the market approach uses:

• Comparable company trading data
  

• Multiples such as P/E, EV/EBITDA, and Price-to-Book
  

• Recent merger and acquisition (M&A) transactions

It results in a market valuation, which reflects what participants in the market are willing to pay under current conditions.

The market approach functions by identifying, analysing, and applying market benchmarks to determine valuation. The key steps include:

1. Identify Comparable Companies (Comps)

Select businesses similar in size, industry, growth, and risk profile.

2. Select Relevant Multiples

Common valuation multiples include:

• Price-to-Earnings (P/E)
  

• EV/EBITDA
  

• Price-to-Sales (P/S)
  

• Price-to-Book (P/B)

3. Analyse Market Transactions

Recent deals involving similar companies help determine what buyers are currently paying.

4. Adjust for Differences

Financial metrics and multiples are adjusted for variations in scale, leverage, margin, and growth.

5. Apply Multiples to the Subject Company

The final valuation is calculated by applying industry-appropriate multiples to the company’s financial metrics.

This creates a valuation based on actual market behaviour rather than theoretical forecasts.

In practice, the market approach is widely used for valuing companies, especially when comparable companies or transaction data are available. Analysts typically begin by selecting a peer group of similar businesses based on sector, revenue scale, business model, and growth rates.

They then calculate valuation multiples for each comparable and derive an industry-aligned benchmark. Finally, this benchmark is applied to the subject company’s financial metrics—such as EBITDA, revenue, or net profit—to estimate a fair market value.

This approach is commonly used in equity research, IPO pricing, M&A valuation, private equity assessments, and fairness opinions.

Here’s how this method adds practical value to valuation exercises:

• Uses real market data, making valuations more aligned with current economic conditions.
  

• Easy to understand, as the method relies on observable prices of similar companies.
  

• Market-relevant, reflecting how investors currently value businesses.
  

• Objective, since it uses publicly available or transaction-backed information.
  

• Widely applicable, especially in active markets with many comparable companies.
  

• Useful for benchmarking, enabling comparisons across industry peers.
  

• Reduces modelling assumptions compared to forward-looking valuation methods.

Here’s where the method may fall short:

• Requires availability of comparable data, which may be difficult in niche or unique industries.
  

• Market distortions, such as bubbles or downturns, can skew valuations.
  

• Differences in size, profitability, and risk may make comparisons less accurate.
  

• Private transaction data may be undisclosed, limiting transparency.
  

• Multiples fluctuate with market sentiment, leading to volatile valuations.
  

• Not suitable for early-stage companies lacking peers or reliable metrics.

The market approach in valuation is a practical and data-driven method that derives value from actual market behaviour. It is widely used in equity markets, M&A, and financial analysis due to its reliance on observable pricing and simplicity. While it offers strong market relevance, it must be applied carefully, considering differences between companies and market fluctuations. Overall, it remains one of the most commonly adopted valuation methods across industries.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.