Peer groups are a group of companies engaged in similar business activities. These companies’ economics and valuations are influenced by closely related factors. These peer groups may not necessarily be classified based on the classification system.
1. Steps of Identifying a Peer Group
Following steps are usually followed for the identification of peer groups:
a. Commercial industrial classification standards (CICS) identify the companies operating in the same industry;
b. The annual reports of the subject company are reviewed for any mention of competitors;
c. The annual reports of such identified competitors are reviewed to identify other comparable companies;
d. Industry trade publications can also be used to identify the comparables;
e. Once it is confirmed that the comparable companies have similar primary business activities, they can be called a peer group.
f. Following questions must be kept in mind while identifying the peer group companies:
i. What amount of profits or revenues is derived from similar business activities? The higher the amount, the better it is.
ii. Do they face the same demand environment? Are they at the same stage of the business cycle?
iii. Do they have a financing subsidiary? If yes, there would be a financing cost; hence it would not be a pure comparison.