What is a Peer Group
A peer group is a group of individuals or entities that share similar characteristics and interests. Peer groups, in the case of people, have characteristics which include similarities such as socio-economic status, level of education, ethnic background, and so on among its individual members.
In the context of financial markets, a peer group refers to companies that are competitors in the same industry sector and are of similar size.
BREAKING DOWN Peer Group
In investment research, peer group analysis is a vital part of establishing a valuation for a particular stock. The emphasis here is on comparing "apples to apples," which means that the constituents of the peer group should be more or less similar to the company being researched, particularly in terms of their main areas of business and market capitalization.
Using Peer Groups
Peer group analysis can enable investors to spot valuation anomalies for a specific stock. For example, a stock that is trading at an earnings multiple of 15x – compared with an average multiple of 10x for its peer group – could justifiably be considered overvalued. Alternatively, investors can uncover the potential reasons for the higher earnings multiple and ultimately determine that it is deserved.
If not immediately obvious, peer groups are sometimes identified by a given company in its 10-K filing and almost always in its proxy filing (Form DEF14A), though the latter can be more expansive in terms of specific business sectors and is used to set 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.