What is a peer group?
A peer group is a group of individuals or entities who share similar characteristics and interests with one another. Peer groups, in the case of people, have characteristics that include similarities such as socio-economic status, educational level, ethnicity, etc. between its individual members. In the business context, a peer group refers to competing companies in the same industrial sector and of similar size.
Key points to remember
- A peer group refers to similar individuals or organizations that share many similarities, making them easily comparable as a group.
- Individual peer groups include people who share similar characteristics such as income, location, age or race.
- Business peer groups include businesses in the same industry or competitors and can be used for peer analysis.
Understanding peer groups
In investment research, peer group analysis is an essential element in establishing an assessment for a particular title. The emphasis here is on the comparison of “apples to apples”, which means that the constituents of the reference group should be more or less similar to the enterprise being researched, especially in terms of their main areas of activity and market capitalization.
Peer group analysis can allow investors to spot valuation anomalies for a specific security. For example, a stock that trades at a profit multiple of 15x – against an average multiple of 10x for its peer group – could rightly be considered overvalued. Alternatively, investors can discover the potential reasons for the multiplication of higher profits and ultimately determine that it is deserved.
If this is not immediately obvious, peer groups are sometimes identified by a given company in its 10-K file and almost always in its proxy file (form DEF14A), although the latter may be more extensive in terms of specific business sectors and be used to define executive compensation plans. Lockheed Martin, for example, lists General Dynamics, Raytheon and Northrup Grumman as peers; it also lists Caterpillar, United Parcel Service and 3M.
Use of peer groups
Peer comparison is one of the most widely used and accepted methods of equity analysis by professional analysts and individual investors. It has proven to be effective and efficient, quickly showing which stocks can be overvalued and which could be good additions to a portfolio. While there are other methods for determining when a security is worth buying, such as discounted cash flow or technical analysis, peer-to-peer analysis remains a key tool for discovering dumped stocks. Read on to learn more about how to use peer comparison as well as how it compares to other types of analysis. Since the data required to perform the analysis is generally public and readily available on financial websites, it is easy for anyone to start using this method of analysis.