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Company Competitors vs. Stock Peers

|Includes: General Electric (GE)

From an investor's perspective, peer grouping definitions have become increasingly intricate due to the ever-growing complexity of listed companies, which range from local and single product firms to global multi-sector conglomerates. The definition of 'peers', will depend on an individual investor's investment strategy and goals. There are no shortage of different investment strategies in use today. With the increase in the availability and complexity of backtesting tools, investors can create and test a strategy with a few clicks. However, there are some widely accepted strategies, both for individual investors and mutual funds, such as value investing, growth investing, or investing based on industry/sectors. The distinction can be drawn between investing based on fundamental indicators such as P/E multiples or economic value added (as in value, growth etc), and the more subjective determination of a company's main business line (industry/sector based strategies).

Why then do we continue to rely on a company's industry as the main determinant of its peers? Some investors may choose to invest based almost entirely on industry performance. This can clearly be seen when, for example, a bank (Bank A) reports strong earnings – shares in the bank's rival (Bank B) will tend to increase based on very little information other than the fact that one of its 'peers' is performing well. Has any additional value really been created by Bank B to warrant the increase in its share price?   Investors are taking a calculated risk, believing that barring any unexpected catastrophe, Bank B's performance will move in-line with its industry.

Industry-based peer lists have the difficulty of grouping all of a company's operations into a single item. Take for example General Electric, a company generally categorized on industry lists as an 'Industrial Conglomerate'. However, the industry title does not convey the company's large media and financial interests.

On the other hand, competitive peer analysis does have its place. Given the commoditized nature of paper products for example, weak results at Paper Company A is a reasonable indicator of weak results at Paper Company B (after taking into account extraordinary items). Paper companies are also more likely to fit solely into the 'Forest & Wood Products' industry category, as they tend to lack multiple major business lines.

Selecting peers purely on the basis of price multiples or other fundamental factors can equally lead to some very disappointing results as they lack the 'common sense' factor that is present in industry analysis. A biotechnology company with the exact same financials as a paper company would likely be trading at a higher price, due to speculation and the reasonable judgment that the biotechnology company has better growth opportunities.

It is clear from an investor perspective that neither categorizing peers purely on the basis of fundamentals or competition is ideal. When we select peers for our StockMarks stock rating system, we take into account 16 different attributes which are grouped into four main categories: market league, business similarity in terms of income streams, technology/non-financial assets and financial structure. Our focus is on the long-term fundamental performance of the company, as this aligns with our investment objectives of sustainable long-term returns. No single definition of 'peers' will suit every investor. Technical analysts for example may choose to completely ignore the industry factor and the company's fundamentals, instead grouping companies by the correlation of their share prices. Nevertheless, it is always wise for investors to be wary of the use of any peer list if it was not created with their particular investment strategies and goals in mind.

Disclosure: No Positions