Who Is My Peer? A Valuation-Based Approach to the Selection of Comparable Firms

This study presents a general approach for selecting comparable firms in market-based research and equity valuation. Guided by valuation theory, we develop a "warranted multiple" for each firm, and identify peer firms as those having the closest warranted multiple. We test this approach by examining the efficacy of the selected comparable firms in predicting future (one- to three-year-ahead) enterprise-value-to-sales and price-to-book ratios. Our tests encompass the general universe of stocks as well as a sub-population of so-called "new economy" stocks. We conclude that comparable firms selected in this manner offer sharp improvements over comparable firms selected on the basis of other techniques.