📚 PASS Research Analyst Certification Examination Difficulty: Beginner ℹ️ Info   ~5 min read
📌 Chapter 10.3 — Sources of Value in a Business – Earnings and Assets

You are sitting at your desk reviewing two mid-cap IT firms in the Indian market. While both companies have similar revenue growth, Firm A trades at a Price-to-Earnings (P/E) ratio of 35x, whereas Firm B is currently priced at 22x. A novice might immediately flag Firm B as the ‘cheaper’ buy, but a seasoned research analyst knows that raw multiples are rarely sufficient.

You must perform a comparative valuation analysis to determine if the valuation gap represents a true market inefficiency or a premium paid for superior capital efficiency and growth prospects.

Comparative valuation, often referred to as relative valuation, operates on the principle of the ‘Law of One Price.’ The premise is that identical or similar assets should command similar prices in an efficient market. By identifying a peer group of comparable companies—same sector, similar market capitalization, and aligned risk profiles—you normalize the target firm’s valuation through multiples like P/E, EV/EBITDA, or P/B. This process allows you to contextualize the absolute value derived from discounted cash flow models against the current market reality.

In the Indian context, effective comparison requires adjusting for idiosyncratic risks. For instance, comparing a debt-laden infrastructure firm to an asset-light software-as-a-service (SaaS) provider is fundamentally flawed due to differences in capital intensity and interest rate sensitivity. You must ensure the peer group shares similar business cycles and regulatory environments. If your analysis indicates that a company’s multiple is significantly lower than its peers despite consistent ROE (Return on Equity), you have identified a potential mispricing that warrants deeper investigation into management quality or balance sheet health.

Ultimately, comparative valuation serves as a sanity check for your intrinsic valuation models. If your DCF model suggests an upside of 40% but the stock trades at a massive premium relative to every viable peer, the disconnect suggests that your terminal growth rate assumptions may be overly optimistic. Use relative valuation not as a substitute for rigorous fundamental analysis, but as a lens to see how the market prices similar risks across the landscape.1

Nuance

⚠️ Nuance
A common pitfall for candidates is the blind application of ‘industry average’ multiples. Analysts often fail to account for the ’liquidity premium’ or ‘size discount,’ assuming that a small-cap firm should trade at the same multiple as a large-cap leader in the same sector. Professional analysts adjust these multiples for differences in growth rates, profitability margins, and financial leverage (the PEG ratio is a classic tool for this). Never accept a multiple in a vacuum; always decompose the components that justify why a firm deserves to trade at a premium or discount relative to the group.

Check Your Understanding

Practice Question 1

An analyst is evaluating a manufacturing company using a peer group. Which of the following factors would most justify a company trading at a higher P/E ratio than its sector peers?

Practice Question 2

When conducting a relative valuation, why is the EV/EBITDA multiple often preferred over the P/E ratio for comparing companies with different capital structures?

This is a companion read for Section 10.3 — Sources of Value in a Business – Earnings and Assets from PASS Research Analyst Certification Examination by Akhilesh Gururani, available on Amazon Kindle.

Copyright © 2026 Akhilesh Gururani. All rights reserved.

  1. Relative valuation assumes that market participants, on average, price assets correctly over the long term, even if individual stocks may be temporarily mispriced. ↩︎