📚 PASS Research Analyst Certification Examination Difficulty: Beginner ℹ️ Info   ~5 min read
📌 Chapter 6.2 — Defining the industry

You are building a DCF model for an Indian mid-cap conglomerate that operates both a high-margin specialty chemical plant and a low-margin commodity textile unit. When it comes time to determine your exit multiple, you face a dilemma: do you use the industry average for chemicals, or for textiles? Selecting the wrong peer group can lead to a valuation that is either dangerously optimistic or unfairly conservative, ultimately skewing your investment recommendation.

Peer group selection is the cornerstone of relative valuation, yet many analysts rely too heavily on static sector labels. A true peer is not necessarily a company that appears on the same page of a Bloomberg terminal or shares the same NIC code; it is a company that shares the same fundamental business risks, growth trajectories, and margin structures.

In the Indian context, where diverse conglomerates are common, an analyst must often apply a ‘sum-of-the-parts’ (SOTP) valuation, peeling away the business units to apply specific multiples to each segment based on their distinct operational realities.

Consider the difference between a pure-play IT services company and a SaaS-based software firm in the Indian market. While both are categorized under ‘Software’ by regulatory bodies, their revenue models differ significantly; the former relies on billable hours, while the latter enjoys high-margin recurring subscription revenue. If you use the trading multiples of the IT services sector to value a high-growth SaaS startup, you will fundamentally undervalue the recurring nature of its earnings.

Effective valuation requires identifying companies that respond similarly to macroeconomic variables like interest rate cycles, raw material price fluctuations, or shifts in domestic discretionary spending.

Ultimately, your choice of peers serves as the benchmark against which you justify your ‘buy’ or ‘sell’ rating. If your comparable set includes firms that are capital-intensive while your subject company is asset-light, your P/E or EV/EBITDA ratios will be distorted, providing a false sense of precision. By building a custom peer group based on economic drivers rather than registry classifications, you ensure that your valuation reflects the reality of the company’s competitive position rather than its administrative filing status.

This discipline prevents the mechanical errors that often lead to poor investment outcomes.1

Nuance

⚠️ Nuance
A common pitfall is the ‘clustering trap,’ where analysts select peers solely based on historical correlation of stock prices rather than fundamental business similarity. Correlation does not imply causality, and two stocks may move together due to index membership rather than shared operational performance. A rigorous analyst ignores short-term price noise and focuses on whether the peer’s operating leverage and competitive moat genuinely mirror the target’s underlying economics.

Check Your Understanding

Practice Question 1

An analyst is valuing an Indian cement manufacturer that has recently expanded into specialized, high-margin construction chemicals. Which of the following approaches is most appropriate for relative valuation?

Practice Question 2

Which of the following criteria is the most reliable indicator that two companies are suitable for direct peer comparison in relative valuation?

This is a companion read for Section 6.2 — Defining the industry from PASS Research Analyst Certification Examination by Akhilesh Gururani, available on Amazon Kindle.

Copyright © 2026 Akhilesh Gururani. All rights reserved.

  1. Relative valuation assumes that similar assets should trade at similar multiples, but this holds only if the business risk profile, growth rate, and ROIC of the chosen peers align with the target company. ↩︎