So you’ve found a stock and want to weigh its merits as an investment by comparing it to its peers. The tendency is to over-simplify the process by only considering companies that have similar products. The purpose of this article is to look beyond just the simple reflection of the stock in question and focus on specific characteristics that will improve your abilities as an investor. The three areas we’ll focus on are sector/industry analysis, investing style and portfolio allocation.

Sector/Industry Peers

At times you’ll find that you have a lot of familiarity with a company and its peers. Maybe you worked in the energy industry for 30 years and the energy sector is a natural for you. However, in order to be diversified, it will require you to wade out into unfamiliar parts of the equity market. A popular tool to help categorize companies by industry is the Global Industry Classification Standard (GICS®). You’ll find that many brokers and websites have this information readily available.

GICS History

GICS® has been around since 1999 and breaks down companies into eleven broad economic categories called sectors. From there they break down into 24 industry groups, 69 industries and finally into 158 sub-industries. The sub-industry level is where you’ll find companies that are the most economically similar. Most ETFs are indexed and frequently borrows from the MSCI GICS® classification system.

Many trading platforms allow you to see sector and industry classifications. Anotehr approach is to go to an ETF fund manager’s website and look at the fund’s holdings. Typically, the top holdings will represent the largest companies since the index weights are typically done by market capitalization. Also, the investor relations page for a company will provide you with a copy of its annual 10-K filing that will detail its competitors and collaborative partners for various aspects of their business.

As an example, let’s use Gilead Sciences Inc. (GILD) and follow this process. GILD belongs to the healthcare sector and the biotechnology sub-industry. From there you could go to a fund manager’s website like iShares and see a list of sector and industry ETFs. On that page you’ll see the iShares Nasdaq Biotechnology ETF (IBB), and on the top holdings you’ll find names like Biogen Inc. (BIIB), Gilead Sciences Inc, Amgen Inc. (AMGN) and Moderna Inc (MRNA). By reviewing a companies 10-K, you can see a description of a company's competition and who they're collaborating with.

Now you’ve found a list of potential peers to compare, it’s now time to decide what to compare.

Peer Comp Investing Style

A peer should be more than just a company that’s in a similar business, but would also require similar types of analysis. Most stocks will typically fall into at least one of the following three investing categories: growth, value or income. When comparing peers, you’ll want to consider whether the companies you’re comparing also fit into a similar investing category.

Growth Stocks

Growth stocks are defined by the potential future earnings growth of the company. Thus, looking at the 5yr Projected Earnings Growth Rate would be a key indicator as to the expected earnings growth observed by sell-side analysts. A typical growth stock will have a minimum of 15-20% projected EPS growth in the next 5 years. Also, evaluating management effectiveness by comparing ratios like Return on Equity (ROE), Return on Assets (ROA) and Net Profit Margin (NPM) would be important to consider. As an investment, you may find that you may have shorter holding periods with growth stocks than if you were simply buying the company for dividends.

Value Stocks

Value stocks represent companies that you feel are currently trading less than they’re worth. Sometimes you might just like a particular industry and are just searching for the best value of the bunch. Some ratios that you may use to compare companies on a valuation basis would be Price-to-Sales (P/S), Price-to-Book (P/B), Price/Earnings (P/E), Price/Earnings to Growth (PEG) or Enterprise Value to EBITDA (EV/EBITDA).

Income Stocks

Income stocks typically pay a quarterly dividend that can be used as a source of income. The rate of income being received is referred to as the Dividend Yield, and is calculated by taking the annual dividend divided by the current stock price. Typically, a stock would be considered as an income investment if the yield is in excess of S&P 500 average dividend yield. You can find the current average yield of 2.13% on www.multpl.com.  Apart from the current dividend yield, other items to compare would be how consistent the dividends have been paid in the prior 10-years, the dividend growth rate over that period, and whether the dividend yield is historically high or low for that stock. Free cash flow and management effectiveness metrics like ROE and the like would be reasonable to compare as well.

Let’s compare GILD and MRNA. GILD has 5-year projected growth rate of 0.02%, a low ROE of 6.46%, a low forward P/E of 8.69, and a dividend yield of 4.8%. You would probably look at GILD as more of an income oriented investment with some potential value characteristics. MRNA is a company that is currently losing money on a GAAP basis with a -29.8% ROE, doesn’t pay a dividend, but has a high 5-year projected earnings growth rate on non-GAAP EPS of 16.8%. MRNA is a company that would be more of a speculative growth stock. Although they are both in the same sub-industry they really aren’t comparable investments.

Portfolio Allocation & Peer Comp

It’s always important to consider where an investment fits in your broader portfolio allocation. Within the equity portion of your portfolio, you might have an allocation for domestic stocks and international stocks. You might have an allocation based on market capitalization, or even differentiate by growth, value or income. For stocks to be peers they would probably fall within the same part of the portfolio you’re looking to invest.

You might even consider two Dow 30 stocks like Microsoft Corporation (MSFT) and Intel Corporation (INTC) as peers even though they are not in the same sub-industry. They are both in the technology sector, are mega-caps and both pay a dividend that is greater than the S&P 500 average. They could be analyzed similarly and could be considered substitutes within a portfolio allocation.

Summary

Peers are more than just companies that just have similar products. They should also be comparable as investments. This means that they would be analyzed as similar styles of investment, and would fall within the same part of your portfolio allocation.