How and why do we compare a stock to its industry?


Stock vs Industry

The second part of our  relative valuation is to compare the stock we’re looking at to other stocks within its industry. While it’s very useful to compare to peers like we did in the previous check, comparing to the industry gives us a greater perspective of where this stock sits in regards to valuation and growth within a wider group of companies.

This part of the analysis compares the key valuation metric determined in 1.1, against others in the industry, and is displayed as a histogram. As you can see in this example we’ve used the P/E ratio because this company is profitable. 
This table below helps us further understand the relationship between growth, value, and risk, and how the stock we’re looking at compares to companies among the wider industry.

Along the bottom of the chart you’ll see the range of ratios from lowest to highest, left to right. Along the side of the chart, you’ll see the number of companies within each bracket. 

We can see where our selected company is by the blue section on the chart, and the blue tab at the top. 

The yellow line here represents the average ratio within that industry. Everything to the left of that in the green section is below the average, indicating that it could be good value, relatively speaking. Everything to the right of the yellow line is above the industry average, and indicates that it could be overvalued, on a relative basis. A stock passes this check if its ratio is in the green section, which adds 1 point to its snowflake valuation score, and it fails this check if it’s in the red section, and gets no points added to the snowflake.

To get more detail, we can hover or click each segment and see which companies fall under which valuation, and exactly how many as well.

While we’re on each segment, we can see in the table below the chart the details of each stock within that group. Here we get some context about each company’s valuation, by seeing how its valuation ratio compares with its forecasted annual earnings growth rate, and market capitalisation.

Typically, you’d expect well established companies with lower expected earnings growth rates to have lower valuation multiples. Conversely, if an early stage company has a high expected earnings growth rate, investors typically pay a higher valuation multiple for it, because they’re willing to pay more for those higher future earnings. 

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