Understanding Peer Groups: Definition, Uses, Examples, Pros & Cons

What Is a Peer Group?

A peer group refers to a group of individuals or companies that share similar characteristics, such as age, education, ethnic background, size, industry, or sector. Peer groups are influential because members often shape one another's decisions, with hierarchies and leaders commonly emerging.

In finance and investment research, peer groups are used to compare company performance and value within an industry. They are also applied across academic, social, and professional fields to analyze behavior and performance among comparable entities.

Exploring the Dynamics of 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 utilized in fields like finance, marketing, and 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:

Companies may list peer groups in their 10-K or proxy filings. Proxy filings often detail specific business sectors and are used for setting executive pay.

How Peer Groups Are Utilized in Finance and Marketing

Peer comparison is one of the most widely used and accepted methods of equity analysis used by professional analysts, individual investors, and professionals.

The Role of Peer Groups in Investment Research

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.

Leveraging Peer Groups in Marketing Strategies

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.

Weighing the Pros and Cons of Peer Group Analysis

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.

Pros of Peer Group Analysis in Investing

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 gives investors a chance to determine certain anomalies and trends that arise with different companies and in the market in general.

Cons of Using Peer Group Analysis

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 be a sizeable group of companies that can be compared to one another.

Understanding Peer Groups Through Real-World Examples

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.

The Bottom Line

Peer groups are groups of similar entities that influence decisions across fields like finance, marketing, and sociology. In investing, they help identify trends and compare company performance, often revealing undervalued stocks.

Because company data is widely available online, peer group analysis is practical, but investors should note its limits, such as bias and market risk.

Investopedia does not provide investment advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor, and might not be suitable for all investors. Investing involves risk, including the possible loss of principal.