Precedent Transaction Analysis

Share market investors need to rely on serious analysis work when choosing to back a particular company’s stock or share. This analysis can come in several forms, one of which is a precedent transaction analysis. With this approach, an investor assumes the value of a company or its stock by studying the valuation of stocks from similar companies in the past.

Understanding Precedent Transaction Analysis Better

Precedent transaction method of analysis uses the data from past transactions of a company or business to estimate the valuation of its current assets. Investors can undertake such a process to acquire the following details regarding their impending deal –

• Precedent transaction valuation assists in figuring out the premiums and multiples payable in a particular industry.
• This process also helps buyers gauge how other parties can arrive at accurate market valuations.

However, one of the major issues with precedent transaction analysis is that buyers cannot emulate the market conditions, which prevailed in the past. Thus, any valuation derived from past transactions is not always as accurate because conditions in the market may have changed drastically since then.

Therefore, the data derived from such an analysis is useful only when investors consider it as a baseline valuation, instead of as an accurate representation of a business’s shares. After such an analysis is complete, they would need to employ further intricate studies to determine the exact market value of stocks in case of acquisitions.

Factors to Consider When Choosing Companies and Transactions for Precedent Analysis

This analysis relies on financial data for the concerned businesses, which must be available to the public. With this information in hand, the next step involves assessing the types of investors who purchased similar stocks from businesses of a similar nature. The circumstances here must be alike as well.

However, selecting the perfect companies and transactions to analyse is key to ensure a fruitful precedent transaction analysis. Here are some factors that you must keep in mind –

1. Companies to be compared must have similar financial standing and must belong to the same sector. Thus, analysis is not feasible when one company belongs to the FMCG industry, while the other belongs to hospitality.
2. The transaction size of the target company should be similar to that being used for comparison. For instance, if the targeted transaction value is Rs. 100 crore, comparing the same to an Rs. 20 crores recorded transaction would not yield beneficial results.
3. The buyer’s characteristics, along with the type of transaction, should be similar in these two instances as well.

Consider three companies named A, B and C to comprehend precedent transaction analysis examples. Suppose, company A and Company C are similar in terms of size, financial standing and other such factors. Company B acquires Company A for Rs.1.2 billion. With precedent transaction analysis, one can safely assume that Company C’s valuation would be similar as well.

Pros and Cons of Precedent Transaction Analysis

Refer to the table below to understand the various benefits and disadvantages of such an analysis process –

What are the Various Uses of Precedent Transaction Analysis?

Precedent transaction analysis template is useful in a wide range of situations, such as –

• The primary use of such an analysis is to attain a realistic idea regarding a company’s worth before acquisition or consolidation.
• It estimates the value of a company, which lacks any public trading comparable.
• The company valuation is based on the demand for acquiring it rather than on its placements in the stock exchange.
• The process can identify sellers and potential buyers within a specific sector.

In most cases, precedent transaction study is used in conjunction with other forms of analysis to arrive at the desired results. This form of valuation offers a general idea regarding the price of a company’s shares and stocks. Nevertheless, investors cannot rely on this data solely. For one, they would need to assess the current market conditions before deciding.

For instance, a change in the number of competitors can alter the valuation of a company’s stocks significantly when compared to the past. Such factors, along with several others, encourage investors to look for other detailed analysis approaches besides this one.