Peer Comparison in Stock Market: What Investors Need to Know

Published by Sharekhan Education | November 4, 2024

The conventional peer comparison valuation methodology falls short in today’s stock market dominated by domestic and foreign institutional investors amid fast-changing market dynamics. This is one way in which the conventional method of assessment-a company’s valuation against other similar companies-is no longer as successful as in the past. Here’s why peer comparison falters and why retail investors need to change gear if they don’t want to get hurt.

Evolution of Market Dynamics

The stock market has become quite different, with the increasing participation of sophisticated institutional investors and rapid dissemination of news that has been a catalyst in driving valuation. For instance, high-growth companies are quickly fairly valued if not overvalued by forward earnings estimates and market sentiment. News flows result in rapid changes in valuation which often create situations where such high growth companies are accorded a premium to the comparable peer group. That would also mean efficiency translates into missed opportunities or chasing the stock after they’ve reached full value, or overvaluation, to a retail investor.

However, companies with fundamental issues may be significantly undervalued compared with their peers. As institutional investors and participants in the market begin to discount for potential risks or deteriorating fundamentals, such firms can trade on lower valuations-even while they seem to be undervalued based upon peer comparison alone. This makes for a really difficult environment for the retail investor, who may find himself investing in apparently attractive valuations without realizing the underlying risks.

Here is an example to showcase the issue. In the below table you will see that when Bangladesh was going through a political crisis, Emami and Marico which had significant sales coming from Bangladesh was trading at a much lower valuation compared to Asian Paints which had much lesser sales coming from Bangladesh. An investor would never know this unless he would have looked at the qualitative factors.

	FY25E EPS	FY26E EPS	FY27E EPS	FY27 PE
Asian Paints	55.8	65.1	73.9	42x
Marico	13.7	16.7	19.1	35x
Emami	22.3	24.8	28.1	29x

 

The Pitfall of Overreliance on Historical Metrics

Retail investors conventionally reach decisions on investment in stocks based on historical or trailing twelve-month metrics like P/E and P/B ratios. Though these ratios could give an indication as to the snapshot of past performance, they exclude future growth potential and risks. In the setting of rapidly changing market conditions and company prospects, over-reliance on historical data could lead to misguided investment decisions.

For example, a company may appear undervalued versus its peers based on TTM earnings, but if its forward prospects are not good, or if the company is facing certain imminent challenges, even then the stock can prove to be a bad investment. Retail investors who do not consider forward valuations, or qualitative factors, risk missing key developments which would explain a company’s future performance.

The Value of Forward Estimates with Adjustments for Probability

The bottom line is that if estimates fail to come forward, it does not matter to the retail investors in particular, who can also place probabilities on their estimates of different outcomes to obtain a more conservative forward valuation. In such an approach, the likelihood of various scenarios, ranging from expansion in growth to potential risks, thereby assigns valuations. The investors can incorporate such probabilities so as to include uncertainties into an already capable valuation model reflecting a wide range of futures.

The Need for Qualitative Research

With these challenges, retail investors need to look beyond simple peer comparisons in stock market and historical valuations. In this respect, absorbing qualitative information in the research reports becomes very important. These reports provide a view of the strategic position of the company, market trends, the quality of the management, and so on, which cannot be deciphered directly from the quantitative data itself.

It puts qualitative research into context, explaining why a company would be valued at any particular level-in which case, it might deserve its premium in light of an innovation pipeline or growth driven by speculative enthusiasm. Conversely, it may flag fundamental problems at companies that look undervalued and could go even lower.

 

How Retail Investors Can Navigate the Modern Market

With this in mind, here’s how retail investors can navigate today’s convoluted stock market:

Include Forward-Looking Valuations:

Ensure that you have factored in earnings estimates and growth projections for the forward position. This gives a better insight into what the future might hold for any company’s stock. It will save you from investing in stocks that are too high because they are already priced for perfection, or very low because their problems are not well-known.

Uncover Qualitative Insights:

Read research reports and analyses that can provide a greater degree of insight into a company’s strategic positioning, its relative standing within its industry, and points of relative vulnerability. This qualitiative perspective supplements quantitative data to make more informed investment decisions.

Employ Probability-Adjusted Valuations:

Rather than agonizing over the possibility of forward estimates not meeting expectations, incorporate probabilities into your valuation models. This allows for a range of potential outcomes and offers up more conservative estimates that better reflect uncertainty and risk.

Stay Ahead of the Market Trends:

Pay attention to news and trends that may influence the course of market prices. Familiarity with prevailing macroeconomic factors, current events about particular industries, and company news will serve as a good background material in which to set these stock prices into perspective.

Conclusion

In today’s ever-evolving stock market, the traditional method of peer comparison can no longer be relied upon as the sole tool for evaluating companies. Retail investors must adapt by incorporating forward-looking valuations, adjusting for probabilities, and digging deeper into qualitative research. Without these added layers of analysis, investors run the risk of chasing overvalued stocks or investing in seemingly undervalued ones without understanding the underlying risks.

To help you navigate these complexities, Sharekhan Education offers free webinars that equip investors with the knowledge and tools necessary to stay ahead in this fast-paced market. These webinars cover everything from market dynamics to strategic stock evaluation methods, ensuring that retail investors can make informed and confident decisions. Don’t miss the opportunity to learn more about how you can refine your investment strategies in today’s stock market.

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