Apples and Oranges – It is difficult to compare companies

ID-10011733As you evaluate performance and price, you should take care to compare companies in the same peer group. When you find an interesting company, you want to make sure it is appropriately priced compared to companies that are in the same basic market segment. These other companies may or may not be direct competitors, but rather are similar in the types of products that they sell and the customers that they serve.

It is important that you do not compare companies that are apples and oranges. You will get few insights as to the quality of the stock by doing this comparison.

It is not fair to compare companies to Apple [stckqut]AAPL[/stckqut] PepsiCo [stckqut]PEP[/stckqut], Cisco Systems [stckqut]CSCO[/stckqut], or General Electric [stckqut]GE[/stckqut] if they are not in the same market segment. You need to compare them against their peer group to make sure that they are managed effectively as compared to their industry norm.

You should not to worry about a standard for P/E for all companies. P/E is the market capitalization of the company divided by its earnings. There are analysts that will create some arbitrary standard on what a reasonable P/E should be. This is not helpful. If you compare companies that are not in the same segment, the P/E of the two companies can be wildly different and probably should be different. They are in different markets with different customer needs that are being fulfilled. Why would you expect that when you compare companies in dissimilar industries that they would be priced the same?

It is appropriate, however, to use P/E to compare companies that are in the same peer group. These companies sell to the same customers and make their products in a similar way.

In general, you want to compare companies and choose those that are better respected than their peers. P/E is a sign of respect from the investment community. The higher the price, the more the investment community respects the company and actively buys the stock. So you want your company to have a higher P/E than its peers.

You do not need to be an expert in each industry to identify its peer group. Others have done this work for you. The easiest way to identify the peer group of a company is to go to Google Finance. You can simply type in the company you are interested in exploring and the site will give you 10 companies that are in the same vertical.

My book, The Confident Investor, goes into great detail how to prioritize P/E among its peer group as you evaluate a stock. You can purchase my book wherever books are sold such as Amazon, Barnes and Noble, and Books A Million. It is available in e-book formats for Nook, Kindle, and iPad.

Image courtesy of Suvro Datta /

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