What Is Precedent Transaction Analysis?

Precedent transaction analysis is a valuation method in which the price paid for similar companies in the past is considered an indicator of a company’s value. Precedent transaction analysis creates an estimate of what a share of stock would be worth in the case of an acquisition.

Key Takeaways

  • Precedent traction analysis uses past performance results of a company to help determine that company's valuation.
  • This kind of analysis is difficult because it is hard to apply market conditions at the time of a previous valuation or during a certain performance period to a current valuation.
  • Precedent traction analysis is a good tool to use when considering a base line valuation of a company but needs to be bolstered by more intricate analysis.

How Precedent Transaction Analysis Works

Precedent transaction analysis relies on publicly available information to create a reasonable estimate of multiples or premiums that others have paid for a publicly-traded company. The analysis looks at the type of investors that have purchased similar companies under similar circumstances in the past and examines whether the companies making the acquisitions are likely to make another acquisition soon.

One of the most important components of precedent transaction analysis is identifying the transactions that are the most relevant. First, companies should be chosen based on having similar financial characteristics and for being in the same industry. Second, the size of the transactions should be similar in size to the transaction that is being considered for the target company. Third, the type of transaction and the characteristics of the buyer should be similar. Transactions that occurred more recently are considered more valuable in terms of usefulness for analysis.

Precedent traction analysis is also known as "M&A comps."

Data sources for precedent transaction analysis include the Securities Data Corporation, which is a repository of mergers and acquisitions data. Trade publications, research reports, and annual filings are also good sources of data.

Advantages and Disadvantages of Precedent Transaction Analysis

While this type of analysis benefits from using publicly available information, the amount and quality of the information relating to transactions can sometimes be limited. This can make drawing conclusions difficult. This difficulty can be compounded when trying to account for differences in the market conditions during previous transactions compared to the current market. For example, the number of competitors may have changed or the previous market could have been in a different part of the business cycle.

While every transaction is different, and thus makes direct comparisons difficult, precedent transaction analysis does help provide a general assessment of the market’s demand for a particular asset and an approximate valuation of the asset. Despite this, this certain type of assessment is more of a generalization since there are so many variabilities to take into account such as competitor size or advantage, market demand, business cycle, and more intricate considerations like exchange rates for import/export companies and geopolitical effects on companies such as those affected by quantitative easing measures or productions caps.