Choosing a peer group for multiples
Peers should share the target's risk, growth and cash flow characteristics. Analysts start from firms in the same industry and refine by size, geography, business mix and life-cycle stage, or group firms by statistical factors such as beta. A multi-industry firm gets a weighted average of segment multiples.
Before this: Valuing with multiples: comparables and forecasted fundamentals, Enterprise value multiples
On the exam
- Determine a potential peer group for multiples-based equity valuation based on a company’s industry classification or specific drivers of expected return
Determine a potential peer group based on industry classification or on the drivers of expected return. Expect the main criterion for peers, how an analyst refines an industry screen, what to do with an outlier, the remedies for concentrated industries, mixed life cycles and multi-industry companies, a segment-weighted multiple, and what a factor-based peer group contains.
How deeply to learn each part
- Know the idea
- Understand it in general. It frames other topics, but you will not calculate with it.
- Use it
- Understand it well enough to solve a question with it. Recognize when it applies.
- Memorize
- Learn it by heart. The exam will not give it to you.
You know this one. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still do.
You tested strong here. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still know it.
What makes a good peer?
Choosing the peers is as important as choosing the multiple, and often the hardest decision. Multiples are driven by growth, risk and cash flow (or profitability), so the ideal peer group , the set of comparable companies used as a benchmark, has very similar values of those. The most important test is not the industry label or the size but peers with similar risk, growth and cash flow .
Memorize
There are two ways to find them. An industry-based peer group holds firms with the same principal business activity. A factor-based peer group holds firms grouped by statistical characteristics that explain equity risk and return, and these firms may sit in different businesses.
- Industry-based Memorize same principal business activity
- Start: a classification system sector and industry codes
- Refine size or geography, outliers, business mix, cost structure, demand, life-cycle stage
-
- Factor-based Memorize similar statistical risk factors, such as beta
- Shares a cost of equity similar expected returns
- May differ in growth and cash flow adjust before judging
-
How do you build an industry-based peer group?
Firms in the same industry face similar competitive forces, suppliers and customers, and investors treat them as substitutes. They are the natural starting point. Industry classification systems sort firms into levels from broad to narrow:
| System | Levels, broad to narrow |
|---|---|
| Global Industry Classification Standard (GICS) | sector, industry group, industry, sub-industry |
| Industry Classification Benchmark (ICB) | industry, supersector, sector, subsector |
| The Refinitiv Business Classification (TRBC) | economic sector, business sector, industry group, industry, activity |
Learning Module 9 explains these systems.
A code is only a start. refining an industry screen means testing the group against the target on a few criteria:
- Geographic reach. A size cut-off can stand in for it: smaller firms often sell in one country only.
- Outliers. An outlier from a one-time item is a peer whose multiple is distorted by an unusual gain or loss.
- Business mix. The business mix is the split of revenue and profit between activities, for example generation against distribution in utilities.
- Cost structure. The cost structure is the balance of fixed and variable costs and the inputs behind them.
- Demand and market structure. Demand differs between markets, and so do cyclicality and market structure.
- Life cycle. The life-cycle stage (start-up, growth, maturity or decline) changes growth and risk.
The advantages of an industry-based group: peers with a similar business mix; consistency with the idea that similar firms with similar cash flows should trade at similar prices; and ranking peers shows the best and worst in class, which helps investors who overweight or underweight within a sector.
What if industry peers do not work, and what are the fixes?
Four challenges come up, each with a remedy:
| Challenge | Remedy |
|---|---|
| A unique firm, or a very concentrated industry with few listed peers | put little or no weight on relative valuation; rely on discounted cash flow (DCF) |
| Peers at very different life-cycle stages (for example research-driven against mature drug makers) | drop peers in a different stage, without leaving too few |
| Same industry, different countries (rules and taxes differ) | adjust for the differences or narrow the group |
| A company spread over several industries | build a peer group per industry and weight the multiples |
- Concentrated industry or unique firm Memorize lean on DCF
- Mixed life-cycle stages Memorize drop peers in other stages, keep enough
- Different jurisdictions Know the idea rules and taxes limit comparability
- Multi-industry company Memorize weight segment multiples by revenue, operating income or assets
In concentrated industries only a few firms are listed, so there is no real distribution of multiples to use. Peers in different jurisdictions face different regulation and taxes, so their multiples are not directly comparable until the analyst adjusts for the differences or narrows the group.
Multi-industry companies need a blended benchmark. The segment-weighted peer multiple weights each segment’s peer multiple by the segment’s share of revenue, operating income or assets.
A company earns 60.00% of its revenue in a business whose peers trade at a median multiple of 11 and the rest in a business whose peers trade at 7.5. Using revenue weights, the peer multiple to apply is closest to:
0.6 × 11 + 0.4 × 7.5 = 9.6
Blended multiple9.6
- 0.6×11+(0.4×7.5)=9.6
- 0.6ENTER11×0.4ENTER7.5×+9.6
ENTER enter (on the HP, puts the number on the stack)
What is a factor-based peer group?
Factor investing identifies statistical characteristics that matter for risk and return and groups companies by them. Factors that earn a long-term premium represent exposure to systematic risk , the market-wide risk that affects all shares and cannot be diversified away. Non-systematic risk , also called idiosyncratic risk, affects one company or industry.
The best-known single factor is the market, in the capital asset pricing model (CAPM) . In it, the expected return on a stock equals the risk-free rate plus beta times the market risk premium. Beta measures how sensitive the stock’s returns are to the market’s returns. A beta above 1 means an expected return above the market’s.
Learning Module 12 estimates beta and the cost of equity.
A factor-based peer group is a set of firms with similar betas, from any industry. With similar betas they have similar costs of equity and similar expected returns.
Advantages of factor-based groups: a more direct link between the grouping and risk and return; if markets are efficient, factor returns are pay for systematic risk, so the group is a fair benchmark for stocks with similar risk while allowing different cash flow and growth; and it gets around the limits of industry groups. Disadvantages: model misspecification , because a relationship found for some stocks in some period may not hold elsewhere, and many factors underperform for long periods or move in cycles.
Industry-based or factor-based?
| Industry-based | Factor-based | |
|---|---|---|
| Grouped by | principal business activity | statistical risk factors, such as beta |
| Peers share | business mix, competitors, suppliers, customers | systematic risk, cost of equity, expected return |
| Strength | similar cash flows and value drivers | direct link to risk and return; works for unique or multi-industry firms |
| Weakness | few peers in concentrated industries; mixed life cycles; multi-industry firms | model misspecification; factors can underperform for years |
Try this 0 of 3
- Screen and refine: change the peer group until the mean and the median of peer P/Es give the same verdict on Arvika
- Multi-industry firm: switch the weighting basis and see the multiple change by more than 0.4
- Factor-based: narrow the beta band until fewer than four peers remain
| In | Company | Market cap | EV/EBITDA | P/E |
|---|---|---|---|---|
| Arvika Paper (target) | 9,500 | 7.2 | 14.2 | |
| Fjellbruk | 14,200 | 6.4 | 12.1 | |
| Lusitana Papel | 3,100 | 5.1 | 8.4 | |
| Rheinzell | 11,800 | 7.0 | 13.5 | |
| Baltica Board | 2,400 | 4.8 | 7.9 | |
| Sundvik | 22,600 | 7.8 | 15.2 | |
| Calder Pulp | 1,900 | 5.6 | 9.0 | |
| Mondoro | 18,300 | 6.9 | 13.0 | |
| Hallin Packaging | 12,700 | 26.5 | 48.0 |
Filled dots are in the peer group, hollow dots are excluded; the dashed line is the peer median.
On P/E, Arvika sits above the median (12.55) but below the mean (15.89): one distorted peer is flipping the verdict. Smaller firms that sell mainly in one country, and a peer whose multiples come from a one-time loss, are not like Arvika.
Show working
Included EV/EBITDA, sorted: 4.8, 5.1, 5.6, 6.4, 6.9, 7.0, 7.8, 26.5 → median 6.65, mean 8.76
Included P/E, sorted: 7.9, 8.4, 9.0, 12.1, 13.0, 13.5, 15.2, 48.0 → median 12.55, mean 15.89
Arvika: 7.2 ÷ 6.65 − 1 = +8.3%; 14.2 ÷ 12.55 − 1 = +13.1%
- 7.2÷6.65−1=EV/EBITDA premium +8.3%
- 14.2÷12.55−1=P/E premium +13.1%
- 7.2ENTER6.65÷1−EV/EBITDA premium +8.3%
- 14.2ENTER12.55÷1−P/E premium +13.1%
ENTER enter (on the HP, puts the number on the stack)
Memorize this
MemorizeBuilding a peer group
| Approach | Peers are | Watch out |
|---|---|---|
| Industry-based | same principal business; then refined by size or geography, outliers, mix, costs, demand, life cycle | few peers in concentrated industries; mixed life cycles; multi-industry firms |
| Factor-based | firms with similar betas, any industry | misspecified models; factors underperform for years |
Memory hook Risk, growth, cash flow: the three things a peer must share.
Know it cold The best criterion is similar risk, growth and cash flow, not the industry label or the size.
MemorizeFixes for awkward peer groups
| Problem | Fix |
|---|---|
| concentrated industry, unique firm | little weight on multiples; use DCF |
| mixed life-cycle stages | drop peers in other stages; keep enough |
| multi-industry company | weighted average of segment multiples |
| outlier from a one-time item | exclude, adjust earnings, or use the median |
Memory hook Blend by weight, never by a plain average.
Know it cold Segment multiple , weights from revenue, operating income or assets.
- Industry-based Memorize same principal business activity
- Start: a classification system sector and industry codes
- Refine size or geography, outliers, business mix, cost structure, demand, life-cycle stage
-
- Factor-based Memorize similar statistical risk factors, such as beta
- Shares a cost of equity similar expected returns
- May differ in growth and cash flow adjust before judging
-
- Concentrated industry or unique firm Memorize lean on DCF
- Mixed life-cycle stages Memorize drop peers in other stages, keep enough
- Different jurisdictions Know the idea rules and taxes limit comparability
- Multi-industry company Memorize weight segment multiples by revenue, operating income or assets
Quick example
Revenue 70% in a business whose peers trade at 9.0 times and 30% in one at 15.0 times: 6.3 + 4.5 = 10.8.
- 0.7×9+(0.3×15)= 10.8
- 0.7ENTER9×0.3ENTER15×+ 10.8
ENTER enter (on the HP, puts the number on the stack)
Quick example
Risk-free rate 4%, beta 1.2, expected market return 9%: 4% + 1.2 × 5% = 10.0%.
- 1.2×5+4= 10.0
- 1.2ENTER5×4+ 10.0
ENTER enter (on the HP, puts the number on the stack)
How it is asked
-
Best criterion
What matters most when choosing peers?
Similar risk, growth and cash flow. Traps: same industry code, similar market capitalization.
-
Segment-weighted multiple
65% of revenue in a 13.0× business, 35% in a 9.0× business.
11.6. Traps: 11.0 (simple average), 10.4 (weights reversed).
-
Factor-based group
Which group is factor-based?
Firms with similar betas, whatever their industry. Trap: all firms in the same industry.
-
Concentrated industry
Only one listed competitor.
Lean on DCF, little weight on multiples.
Exam traps
- Taking every firm in the industry code as the final peer group without refining it.
- Averaging segment multiples equally instead of by revenue, operating income or assets.
- Calling beta a correlation; it measures the sensitivity of a stock's returns to market returns.
- Assuming factor-based peers share growth and cash flow; they share systematic risk.
- Keeping a peer whose multiple is distorted by a one-time loss in a mean.
- Forcing multiples on a near-unique firm; lean on DCF instead.
Checkpoint
3 exam-style questions. About 90 seconds each.
1A company earns 75% of its revenue from a business whose peers trade at a median enterprise value (EV) to earnings before interest, taxes, depreciation, and amortization (EBITDA) multiple of 16.0 and 25% from a business whose peers trade at 8.0. Using revenue weights, the peer multiple to apply is closest to:
2Under a factor-based approach, the final peer group for a company is best described as:
3A company is one of only two listed firms in its industry. In valuing it, an analyst should most appropriately:
Key takeaways
- Peers should share risk, growth and cash flow characteristics; that matters more than the industry label or size.
- Industry-based groups start from a classification system (GICS, ICB, TRBC) and are refined by size or geography, outliers, business mix, costs, demand and life-cycle stage.
- Concentrated industry: lean on DCF. Mixed life cycles: drop peers in other stages. Multi-industry firm: weight segment multiples.
- Factor-based groups collect firms with similar betas across industries; they share a cost of equity, not growth.
Quick example
Revenue 70% in a business whose peers trade at 9.0 times and 30% in one at 15.0 times: 6.3 + 4.5 = 10.8.
- 0.7×9+(0.3×15)= 10.8
- 0.7ENTER9×0.3ENTER15×+ 10.8
ENTER enter (on the HP, puts the number on the stack)
Quick example
Risk-free rate 4%, beta 1.2, expected market return 9%: 4% + 1.2 × 5% = 10.0%.
- 1.2×5+4= 10.0
- 1.2ENTER5×4+ 10.0
ENTER enter (on the HP, puts the number on the stack)
All Equities formulas, every lesson
Practice exam-style questions on Relative Valuation with Multiples
Questions about this lesson?
Where this comes back
- Trailing, current and forward multiples Relative Valuation with Multiples
- Industry classification: GICS, ICB, TRBC and other groupings Industry and Competitive Analysis
- Estimating the cost of equity with the CAPM and the market model The CAPM, the Market Model and Factor Models
Questions candidates ask
How do you choose a peer group in CFA Level 1?
Start with firms in the same industry, then refine by size or geography, business mix, cost structure, demand and life-cycle stage, and remove outliers. Alternatively group firms with similar betas. In both cases peers should share risk, growth and cash flow characteristics.
What is a factor-based peer group?
Companies grouped by statistical factors that explain risk and return, such as beta, whatever their industry. They share systematic risk and a similar cost of equity, but may differ in growth and cash flow.
How do you value a company in several industries with multiples?
Find a peer multiple for each industry and take a weighted average, using the share of revenue, operating income or assets in each.
Spotted an error? Tell us and we will fix it.