Comparable Company Selection: Defending the Inclusions and Exclusions

MILES Valuation Advisory — Insights

Executive Summary

Auditors ask two questions about a comparable company set: why these companies, and why not those. A persuasive answer requires a record of the search, the selection criteria and the judgements behind each material inclusion or exclusion. Defining the initial criteria before reviewing the multiples helps reduce the risk of selecting peers to support a preferred outcome. Those criteria may evolve as the analysis develops, but changes need a business rationale and consistent application. This article explains how to handle that process, assess boundary cases and show the effect of disputed exclusions.

Why the Exclusions Matter

“Why these companies?” can usually be answered by describing their industry, geography and scale.

“Why not those?” requires more. A reviewer may identify a company with a similar business that does not appear in the final list. The valuer needs to show whether it fell outside the search, failed a selection criterion or was excluded after further analysis. Each answer raises a different question about the work performed.

In our experience, the difficult discussions often begin when the file preserves only the final list. Without the original search results and the reasoning behind the exclusions, a reviewer cannot readily distinguish a considered judgement from a convenient omission.

How a Peer List Goes Wrong

The screen runs on industry codes and produces candidates. The multiples are computed and look unexpectedly high, low or dispersed. The valuer revisits the list, removes several names and writes selection criteria describing the companies that remain.

There may be a sound explanation. Further research might reveal a different revenue model, an acquisition that makes historical earnings unrepresentative, or a material data error. But the same sequence can also produce a list selected to support an expected valuation.

The pressure need not come from a transaction party. It can arise from the honest reaction that an unexpected result must mean the wrong peers were chosen. An unusual multiple is a reason to investigate. By itself, it does not establish that a company is unsuitable.

A defensible file records what the investigation found, why it matters and whether the same reasoning was applied to other candidates. The substantive explanation and the chronology both matter.

What Hong Kong Regulators Expect

The AFRC, in its Audit Focus for 2025 year-end audits, asks auditors to examine how management identified comparable companies and transactions and to challenge the exclusion of apparently more relevant candidates. It places this reminder within its discussion of fraud risks and management bias. Selection therefore warrants scrutiny beyond checking the arithmetic. AFRC, p. 6

The SFC takes a related position in its July 2019 statement on directors’ conduct in acquisitions and disposals. It calls for a fair, representative sample and a defensible explanation of how comparables were assembled. Its concerns include selecting companies with higher multiples while disregarding poorer performers. SFC, “Fair presentation of comparables”

HKEX Guidance Letter GL116-23 addresses disclosure for notifiable transactions. Paragraphs 15–16 call for selection criteria with quantitative benchmarks, reasons for those criteria, justified exclusions and information demonstrating consistent application and an appropriate, complete set. The examples of inadequate disclosure include vague business descriptions and outlier exclusions unsupported by the identities and multiples of the companies removed. These are transaction disclosure expectations, rather than a universal checklist for every valuation. HKEX, paragraphs 15–16

These specific passages do not set a numerical minimum for comparable companies. That does not establish a universal rule about sample size. It does mean that reaching a particular count does not, on its own, answer the questions they raise about selection quality.

Define the Search, Then Preserve the Decisions

Our starting point is the subject’s business: how it earns revenue, which risks it bears and what drives its margins, growth and capital requirements. Industry classifications help locate candidates, but the screening criteria need to reflect those economics.

The initial record should identify the database, search date, valuation date, geographic coverage, industry filters and operating criteria. Where a criterion is quantitative, both the threshold and its rationale should be clear. A segment-revenue threshold, for example, needs to reflect the relevance of that segment to the subject rather than simply produce a convenient number of companies.

Apply the criteria across the defined search population and retain the results. For candidates requiring further review, record the evidence and decision. A relevant company identified outside the initial search should prompt a check of the search coverage, including whether the same gap may have missed other candidates.

Criteria can change. A review of annual reports may reveal that an initial classification was too broad or that a different operating measure better captures comparability. Record the original criterion, the revision and its business rationale, then reassess the affected population consistently. If the revision follows a review of multiples, preserve that chronology and explain the underlying evidence. A change that affects the valuation materially also warrants an explanation of its impact.

Decide Boundary Cases on Comparability

Some candidates will be close to the threshold or combine a relevant business with substantial unrelated operations. The question is how those differences affect their usefulness for the valuation.

Having enough names already is not a sufficient reason to exclude another company that meets the criteria. Nor does a tighter spread of multiples establish that a smaller set is better.

For a borderline candidate, examine the relevant segment, revenue model, customers, growth, profitability, capital intensity and data quality. Decide whether the differences can be understood and, where appropriate, adjusted for reliably. If material differences remain, explain why they prevent inclusion in the primary set. Where informative, present a supplementary analysis incorporating the candidate and show how the result changes. The distinction between the primary and supplementary sets must itself have a consistent basis.

It is also necessary to separate company eligibility from the usability of a particular multiple. A loss-making company may provide no meaningful P/E observation but still offer relevant evidence through another appropriate metric. A distorted earnings figure may require normalisation supported by evidence. Neither situation automatically makes the company unsuitable for every part of the analysis.

The following simplified examples illustrate the decisions a working file might record. They are hypothetical, not prescribed treatments.

The full record should link decisions to source documents, identify the reviewer and preserve material changes. It should allow another professional to follow the judgement even if they ultimately disagree with it.

When the Search Produces Few Comparables

A small set requires an assessment of evidence quality and sensitivity. Consider whether individual observations dominate the conclusion, whether data are reliable and whether differences from the subject can be addressed. Adding weak comparables can create an appearance of breadth without improving the estimate.

If the search needs to expand, identify which restriction can be relaxed with the least loss of economic relevance:

• Geography: A wider search may be useful where revenue models and customer economics are similar. Differences in regulation, market growth and risk still need assessment.
• Industry classification: An adjacent industry may contain businesses with a more relevant operating model than some companies within the original code.
• Products: Producers of close substitutes may be informative where demand, pricing and cost structures are sufficiently similar.

Apply the revised criteria consistently and explain the remaining limitations. Expansion may still fail to produce reliable market evidence. In that case, reassess the weight placed on the market approach and whether another approach provides better support.

For novel or innovative businesses, GL116-23 paragraph 11 specifically asks issuers to explain the suitability of the market approach when similar companies are absent. Identifying a relaxed criterion is only part of that explanation. HKEX, paragraph 11

A Published Example: Showing the Effect of Exclusions

Hua Hong Semiconductor’s response to a Shanghai Stock Exchange review inquiry, published on 29 May 2026, illustrates how exclusion judgements can be made visible. The inquiry concerned the valuation of Huali Microelectronics (華力微), including the exclusion of SMIC and differences between the peers used for valuation and financial analysis.

The response cited differences between SMIC’s advanced manufacturing processes and the target’s mature process technologies. It also simulated using the wider financial-analysis set, adding SMIC, Hua Hong Company and United Nova Technology (芯聯集成). The resulting valuation was RMB9.52 billion, compared with the announced valuation of RMB8.48 billion: an increase of approximately 12.3%, calculated from the disclosed figures. This was a comparison with the announced valuation, not the transaction consideration, and reflected three additional companies rather than SMIC alone. Hua Hong Semiconductor, response to Question 4, pp. 6-1-42–6-1-46

The useful practice is to present the exclusion rationale alongside its numerical consequences. Sensitivity analysis makes the judgement easier to examine; it does not independently prove that an exclusion was appropriate or that a regulator endorsed it.

Practical Implications

For entities preparing financial statements: Preserve the search and selection record alongside the valuation report. Make sure the business information used to assess comparability is supported, and that material changes in criteria or peer composition are explained.

For auditors: Ask about both the selected companies and plausible alternatives. Where a candidate was excluded, examine the underlying evidence, consistency of treatment and effect on the conclusion. A recorded explanation is a starting point for evaluation, rather than proof of its adequacy.

For valuation practitioners: Build the record as the work proceeds. Retain initial screens, source evidence, revisions and decisions on boundary cases. Explain separately why a company is comparable, which of its metrics are usable and how much reliance the valuation places on the resulting evidence.

Conclusion

A defensible comparable company set allows a reviewer to trace the path from the subject’s economics to the search population, selection decisions and valuation conclusion. Initial criteria provide discipline; supported revisions allow professional judgement to respond to new evidence. The final list becomes persuasive when that reasoning is visible for both the companies included and those left out.

References

• AFRC, Audit Focus for 2025 year-end audits, 3 October 2025, printed p. 6.
• SFC, Statement on the Conduct and Duties of Directors when Considering Corporate Acquisitions or Disposals, 4 July 2019, “Fair presentation of comparables”.
• HKEX, Guidance Letter HKEX-GL116-23, Disclosure of the basis of consideration and business valuations in notifiable transactions, October 2023, June 2024 revision, paragraphs 11, 15 and 16; linked Chinese marked-up edition.
• Hua Hong Semiconductor Limited, overseas regulatory announcement containing the response to the Shanghai Stock Exchange review inquiry concerning its acquisition of assets through a share issue and related-party transaction, 29 May 2026, Question 4, printed pp. 6-1-42–6-1-46.

This article is prepared for general information purposes and does not constitute audit, accounting, or valuation advice. Readers should refer to the relevant primary publications and applicable valuation standards for authoritative guidance.

About MILES Valuation Advisory

MILES Valuation Advisory is an independent valuation firm based in Hong Kong, providing audit-defensible valuation services across Business Valuation, Purchase Price Allocation, Impairment Testing, Share-Based Payment Valuation, and Financial Instrument Valuation to listed companies, IPO candidates, and transaction parties across Greater China.