Stick to the Fundamentals and Discover Your Peers

The use of industry as a criterion for selecting peers for multiples-based valuation rests on the notion that companies operating in the same industry are more likely to share fundamental value drivers (i.e., profitability, growth, and risk). However, such companies may not have similar characteristics in terms of these drivers and thus should not be traded at the same multiple. We analyze this issue by developing the sum of absolute rank differences (SARD) approach. The SARD approach can account for an infinite number of proxies for profitability, growth, and risk while remaining independent of industry classifications. Our results indicate that the SARD approach yields significantly more accurate valuation estimates than the industry classification approach.Disclosure:The authors indicate no conflicts of interest. Editor’s NoteThis article was externally reviewed using our double-blind peer-review process. When the article was accepted for publication, the authors thanked the reviewers in their acknowledgments. Alok Kumar Agarwal, CFA, and Michael Fuerst were the reviewers for this article.Submitted 6 March 2016Accepted 28 December 2016 by Stephen J. Brown