How do you deal with outliers and non-recurring items in market data?

Why not consider outliers as opportunities rather than anomalies? Identifying outliers can reveal unique market insights or uncover hidden trends that others may overlook. As Peter Thiel suggests in "Zero to One," look for secrets hidden in plain sight. An outlier could signal a disruptive innovation or a niche market ready for exploitation. By investigating outliers, you may discover valuable information that standard analysis misses.

We are typically not talking about large data sets here, so this is not outlier analysis in a statistical sense. Finding even 20 super-relevant multiples of relevant transactions is pretty hard. We would typically find the median, and multiples far away from the median would be considered outliers. Generally, there are also multiple multiples (e.g. Revenue, EBITDA; Each for last year and this year), so the exercise is not as much of a mathematical exercise as it is a judgment and qualitative exercise.

Make a range of valuations, and then highlight the most likely scenarios. I find a table with the biggest drivers on each axis works well for this

In handling outliers & non-recurring items within market data, it's imperative to employ a meticulous approach. Firstly, identifying these anomalies requires a keen eye for detail coupled with robust analytical tools. Once detected, a thorough assessment is necessary to understand their underlying causes and potential impact on the overall dataset. Subsequently, devising tailored strategies to mitigate their influence ensures data integrity and enhances decision-making processes. Collaboration with cross-functional teams and leveraging industry expertise further fortifies the efficacy of these efforts. Ultimately, maintaining vigilance and adaptability in navigating such complexities fosters a more resilient and informed market perspective.

This is much more difficult. The comments in this article make is seem like you have access to vital information such as capital structure for all of the comps in the data base. That would be great, but even if you do how much time do you have. Every company is different, so I have a problem when we refer to an industry EBITDA or ODE multiple. Within any given industry with an average multiple of 5, there are companies that sold at 3 multiple and others at 10 multiples.

Before deciding whether to exclude or include outliers, do the research to figure out why it is an outlier in the first place. Common reasons I've seen are: 1) when the target was small but fast growing, with high topline growth but lower profitability - causing the EBITDA valuation multiple to look high. 2) when the target had intellectual property or had other barriers to entry that don't show up in the financials - again causing the multiple to look high because the acquirer is paying for the strategic value of the business. Its not always possible to get this information, especially for private transactions, but understanding the reason for the outliers can also help understand the other (non-outlier) valuations better.

When dealing with outliers in market data, it's crucial to strike a balance between accuracy and relevance. Excluding outliers can enhance the reliability of valuation, but it can also lead to a loss of valuable insights if done excessively. Analysts should employ robust statistical methods to identify outliers and consider the context of each data point. Understanding the underlying reasons for outliers—such as market anomalies or unique business circumstances—can provide critical insights into industry trends. A nuanced approach that combines exclusion, adjustment, and comprehensive analysis of multiple data sources will yield the most accurate business valuation.

I pay for various data providers and choose my comps from companies with similar sales and earnings within the same industry. I often find that there are not really enough comps to be statistically relevant, even with these broad parameters. (Oh, I also assume that the reported earnings have been adjusted for non-recurring and non-market expense items, what else can you do?) I then compare the databased search multiple results to industry averages published by companies like Dun & Bradstreet.

To identify non-recurring items, we must examine the financial statements thoroughly including notes to accounts and various disclosures w.r.t. specific transactions and events. Such items are backed by unusual entries which deviate from the company's typical operational activities or financial patterns. We must apply our judgement to assess whether the identified items are potential non-recurring items or not, keeping in mind about nature of the event, the company's business model, and management's commentary on the matter. Recognizing and properly accounting for non-recurring items is essential for conducting an accurate business valuation.

I’ve found the review of financial statements for normalization and adjusting for non-recurring items to be extremely important and a pivotal aspect of any valuation engagement. Keep in mind the company’s business cycle and extraordinary events during the year such as COVID related expense items not expected to occur in the future impacting the financial statements.

Ask yourself these questions to identify non-recurring items: 1) Is this an expense that's happening every period (every year / quarter) or is it truly one-time? 2) What would happen if the business stopped this expense? Is the expense necessary for the business to operate as usual? 3) If reviewing the adjustments that are included in someone else's analysis (e.g. a sellside banker), understand how including or excluding the adjustment affects their position and the business' valuation.

After the Pandemic, we all can agree that some events happens once in a decade and such as COVID was one of them. While adjusting those non recurring expenses happened during those times, but while adjusting those factors you need to understand or review company's data to see if any due amount which was pending for a long time and it was incurred due to core business operations. So correct identification of those items is important.

This article is about two very different things. Every valuation methodology requires that non-recuring and non-market-based expenses, rent, compensation etc., be identified and adjusted. If the business owner is not willing to share these things, you cannot really do a business valuation. Most will as they usually want an accurate valuation. Sellers are more than willing to tell you about overstated non-market-based expenses as they want you to come to a higher value.

Adjusting non-recurring items often feels like turning fiction into fact. While normalizing earnings for valuation, consider that some "non-recurring" items may recur under different guises. As Warren Buffett wisely notes, "Beware of companies displaying accounting gimmicks to dress up their numbers." Ensure adjustments reflect genuine business realities, not just theoretical cleanliness.

We commonly do at least a comparables method (e.g EBITDA multiples) and a DCF (discounted cash flow). If these diverge a lot, it means that we have some work to do to understand why. The multiples used also vary by industry. EV / EBITDA and EV / Revenue are the most common. But other multiples include for example, EV / Subscriber count (for telecom), price / square foot ( for retail), or EV / Daily active users (for social media). Pick the right multiples that companies in the industries are valued by, and find current multiples, especially if you're looking to transact soon.

Yes, the key is multiple valuation methods! After I get my market comp number, I can compare to the other two or three valuation calculations I have made for the subject company. If they correlate great! If not, I have more work to do.

Utilizing multiple sources and methods in business valuation is essential for achieving a comprehensive and accurate assessment. By triangulating data from various databases and employing diverse valuation multiples, analysts can better understand the nuances of market dynamics and mitigate the risks associated with reliance on a single data point. This multifaceted approach not only enhances the robustness of the valuation but also fosters greater confidence among stakeholders, as it demonstrates due diligence in addressing potential outliers and non-recurring items.

Sometimes companies have serial non-recurring items in their statements. I remember a particular company I used to cover as an analyst that always had new restructuring charges in their p&l and balance sheet every quarter. So if the company you're looking at has the same type of non-recurring charges every period then they're no longer non-recurring and should be treated as such..

Always look beyond the numbers—consider the narrative behind them. A company's story, its management decisions, market position, and strategic vision are crucial. As Simon Sinek says, "People don’t buy what you do; they buy why you do it." Understanding the 'why' behind financial data offers a holistic view. Combining quantitative and qualitative analysis provides a more robust valuation perspective.