What Is a Peer Group?
The term peer group refers to a group of individuals or companies that share similar characteristics with one another. These characteristics may be age, education, ethnic background, size, industry, or sector. Peer groups are known for their influential nature as they are able to shape the decisions of members of the group. As such, peer groups often contain hierarchies, with clear leaders who sit at the top. Peer groups are often used in analysis in a number of academic and professional fields.
- A peer group consists of individuals or organizations that share similar characteristics.
- Peer groups are known for their influential nature as they're able to shape the decisions of other group members.
- These groups often contain hierarchies with clear leaders who sit at the top.
- Peer groups are commonly used for analysis in a number of fields, including financing, marketing, and sociology.
- Peer group analysis in investing involves the use of financial data to compare similar companies to one another.
Understanding Peer Groups
As noted above, peer groups contain a number of people or other entities that share one or more similar characteristics. Peer groups allow individuals to be grouped together by certain defining features, such as age, income, education, race, and/or gender. Qualities among members for corporate peer groups include size, industry, sector, and/or financial position.
Peer groups are used in a number of different fields, such as finance and marketing, as well as sociology. They are known for the influence they have among group members. They consist of hierarchies, which place one or a few individual group members at the top. These members can often shape the actions and decisions of the other group members.
Peer group analysis or peer comparison involves an apples-to-apples comparison. This means the constituents of the peer group should be more or less similar to one another. Comparisons allow professionals to identify trends and anomalies in behavior and outcomes, and give them an opportunity to figure out efficiencies and opportunities:
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, though the latter can be more expansive in terms of specific business sectors and is used to set executive compensation plans.
Insurance companies compile peer groups to underwrite life or health insurance policies on certain demographics, such as age-related groups or those who do or don't smoke.
Using Peer Groups
Peer comparison is one of the most widely used and accepted methods of equity analysis used by professional analysts, individual investors, and professionals.
Because companies in a peer group share similar traits, they lend themselves to relative value analysis. Peer group analysis establishes a valuation for stocks in investment research, as long as the group consists of companies similar to the one being researched. This is especially key when it comes to business areas and market capitalization. Investors can use this analysis to spot valuation anomalies for certain stocks.
For example, a stock trading at an earnings multiple of 15x (compared with a 10x multiple for its peer group) may be considered overvalued. Investors can uncover reasons for the higher earnings multiple and ultimately determine that it is deserved.
Relative valuation among peers in a group can be efficient and effective, quickly showing which stocks may be overvalued, and which might make good additions to a portfolio. While there are other methods to determine when a stock is worth buying, such as discounted cash flow or technical analysis, peer comparison analysis remains a key tool for uncovering undervalued stocks.
Because the data necessary to conduct the analysis is generally public and readily accessible on financial websites, it is easy for anybody to begin employing this method of analysis in order to identify opportunities.
Peer group comparisons are also called comparables or comps.
Peer groups are important in advertising and marketing, especially in the age of social media. Leaders in the group or those who are at the top of the hierarchical ladder are commonly known as influencers. Professionals study peer groups to show how they influence buying patterns and consumer trends for advertising and product development purposes.
Advantages and Disadvantages of Peer Groups
Peer group analysis helps shape many decisions in the financial and investment worlds. There are a number of different benefits to using peer groups, especially in investment analysis. But just like any other analytical tool, there are drawbacks to this form of analysis as well. We've listed some of the most common ones below.
One of the most obvious benefits of using peer group analysis is that it helps investors and analysts uncover undervalued stocks. This is often accomplished by analyzing different metrics, including leverage and profitability among others. Doing so allows the individual to determine companies that should carry higher-than-average valuations. A stock may be considered a buying opportunity if the current valuation is lower than what seems reasonable.
Investors and professionals don't have to go far to get the information they need to perform peer group analysis. Data is easily available, either on company websites or through filings done with the Securities and Exchange Commission (SEC). This means the individual doesn't need to do exhaustive research.
Conducting peer comparisons give investors a chance to determine certain anomalies and trends that arise with different companies and in the market in general.
Doing a peer comparison isn't as easy as it seems. That's because quantitative factors aren't the only considerations. In fact, there are qualitative issues that must be taken into account. This means that the analysis can be fairly subjective.
Peer groups often come with certain biases, which can sway an analyst or investor's analysis. For example, some groups come with survivorship bias. This means that the peer group may not contain any companies that underperform. This type of analysis, therefore, doesn't take companies that have gone under or phased out of the group into account.
There may not be very many companies in the peer group. When this is the case, peer comparison becomes ineffective. In order for it to work, there needs to get a sizeable group of companies that can be compared to one another.
Helps uncover buying opportunities for undervalued securities
Accessing data is easily available for comparison
Allows anomalies and trends to be identified
May be subjective because some investors also consider qualitative factors into account
Survivorship bias doesn't account for members that are phased out of the group
May not be enough companies in the group
Example of a Peer Group
Peer groups refer to companies that are in the same industry or sector. These are competitors that are roughly the same size. Peer groups can be found in analyst research reports or an individual company's financial statements.
Lockheed Martin is an aerospace, defense, and security company headquartered in Maryland. According to the company's 2017 proxy statement, its peer group consists of other similar companies as its peers, including General Dynamics, Raytheon, and Northrup Grumman. It also lists Caterpillar, UPS, and 3M.
Peer Group FAQs
What Are the Types of Peer Groups?
There are several different types of peer groups, including social groups (cliques, sports teams, etc). In investing and finance, peers may be grouped by industry or sector (consumer staples, retail, telecoms), size (usually by market cap), financial health (profitability, capital structure), or business factors (business models, location, seasonality).
What Is Peer Group Analysis?
Peer group analysis is a process involving the comparison of entities that share similar characteristics. It is an apples-to-apples comparison of subjects that are fairly similar to one another. This kind of analysis allows for the identification of trends and anomalies in behavior and outcomes.
What Is a Peer Group Index?
A peer group index is one that groups individual companies together into a single, benchmark index. For instance, the S&P 500 can be considered a peer group index. This index is comprised of 500 of the largest public companies in the United States and is generally considered the best gauge of U.S. large-cap equities.
How Can You Use a Peer Group Average in Investing?
A peer group average is considered one of the most effective and efficient ways to determine the valuation of a security. Put simply, investors can use certain metrics drawn from corporate financial statements to assess a certain company's stock price compared to its peers.
Why Are Firms Classified Into Peer Groups for Ratio Analysis?
Companies are grouped into peer groups for ratio analysis as part of fundamental analysis. It allows researchers to determine individual company liquidity, efficiencies, as well as profitability. This is done by examining each company's past and current financial statements and comparing them with one another. Some of the most popular ratios include price-to-earnings (P/E), price-to-book, and price-to-dividend ratios.
The Bottom Line
Peer groups consist of similar entities that share one or more characteristics in common. They serve a very important purpose in many different fields of study. They can be one of the most useful tools when it comes to equity analysis for investors and financial professionals. Anyone can perform peer group comparisons using information that is widely available on corporate websites or through the SEC.