Peer Pressure

Abstract

Investment bankers focus on narrow industry-based peer groups for individual stock valuation, and some market-neutral equity hedge fund managers restrict portfolios to be sector-neutral. Despite the academic research that typically ignores industry effects, the evidence is that industry effects matter. Narrow industry-based peer groups improve stock valuation precision for three key valuation ratios. In a sample including the boom and bust period of the late 1990s, contrarian strategies were particularly profitable for Nasdaq-listed stocks. For the full sample of stocks, an industry-neutral strategy is better than an industry-exposed full universe strategy in Sharpe ratio terms over every horizon for each valuation ratio.

TOPICS: Accounting and ratio analysis, equity portfolio management, portfolio construction