Invest In Your Peers: A Fundamental Approach to Peer Selection and Investment Strategy

Samuel Klein & Edvinas Belousovas

Student thesis: Master thesis


In this paper, we analyze a proprietary model that selects peer groups for individual firms based on fundamental valuation principles. Using the sum of absolute values approach, we identify peers based on single and multiple factors representing profitability, risk and growth characteristics. To determine whether peer selection is accurate, we compare the relative value of the base company to the peer group through enterprise value and price multiples. Furthermore, we tested the robustness of the peer selection by using different peer group sizes, 6 or 12 peers, and firm fundamentals based on single year or 3-year average values. This model was tested in developed and emerging markets, like indices in the U.S., Europe, and MSCI Emerging Markets. Results differed between markets; in Europe and emerging markets we reject the idea of enhanced robustness, however in the U.S. the accuracy tends to improve. Overall between markets, the analysis illustrates that peer selection accuracy typically improves when multiple fundamentals are adopted. The investment strategy component of the paper is based on the theory of mean reversion. We select the 20 most undervalued firms relative to their respective peer group to form a portfolio. The argument for this approach is based on the theory that our peer group should represent what the base company is worth, so buying the undervalued firm would result in convergence towards the mean relative value and therefore price appreciation all else equal. We measure the return and risk performance from 2004 to 2018 through a historical simulation. The results show portfolios in the emerging markets have the highest total return and most significant alpha, suggesting that markets are the least efficient. Risk-adjusted return for the U.S. is on par with emerging markets, whereas Europe has the lowest. The portfolio risk as measured by maximum drawdown was lowest in emerging markets despite highest volatility of the indices. Overall, the various portfolio strategies outperformed their respective benchmarks on risk-adjusted return and presented positive alpha, though some strategies are riskier

EducationsMSc in Finance and Investments, (Graduate Programme) Final Thesis
Publication date2019
Number of pages134