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Taking Peer Group Analysis One Step Further for Analyzing Competitors

There’s many superficial ways to make a peer group analysis as part of evaluating an industry, or a company’s competitive advantage against its competitors. I think putting yourself into the shoes of management(s) is a much more in-depth and insightful approach.

Part of analyzing a company’s competitors and industry is by creating an industry map. This involves a list of all of the other companies (or companies’ segments) which earn revenue in the same market as your company.

This information isn’t always easily or freely available, due to the less stringent rules of segment accounting and the presence of private (non-publicly traded) competitors. I think most websites which display peers or competitors in an industry don’t do a through job, so I highly recommend reading multiple annual reports (10-k’s) to create a more accurate industry map.

Once the base industry map is created, the peer group analysis is started, not finished.

This post will cover the following aspects of this type of an analysis:

  • Introducing the Competitor/ Peer Analysis Framework
  • The Competitor’s Motivations
  • The Actions of Competitors
  • More Peer Group Analysis Considerations
  • Investor Takeaway

I think an analyst or investor can find great benefit from creating what Michael Porter called “A Framework for Competitor Analysis”.

Doing this goes past some of the more common methods of peer group analysis such as relative valuation ratios, comparisons of margins, or growth, etc.

This kind of a deep peer analysis might not be applicable to all, or even many, of the businesses you analyze over a career or investing lifetime. But in the cases where it does, this deeper understanding can create a serious circle of competence and conviction about a company and its place in its industry.

Introducing the Competitor/ Peer Analysis Framework

If this topic is very interesting to you, then I highly recommend referencing the original text in which these ideas were presented: Competitive Strategy by Michael E. Porter.

To try a brief synopsis, there are two main components to observe about a competitor/ peer:

  1. The competitor’s motivations
  2. The actions of the competitor, and potential future actions

Within these two main components are four sections, with FUTURE GOALS and ASSUMPTIONS comprising the motivations and CURRENT STRATEGY and CAPABILITIES encompassing the actions.

From there, Porter argues the following questions to ask about how this peer may react, which he coined as the COMPETITOR’S RESPONSE PROFILE:

  • Is the competitor satisfied with its current position?
  • What likely moves or strategy shifts will the competitor make?
  • Where is the competitor vulnerable?
  • What will provoke the greatest and most effective retaliation by the competitor?

All-in-all, as investors or analysts we can create a profile for each main competitor in a market, to aggregate a complete peer group analysis through a deep dive into each, and then sum the findings into a comprehensive picture.

Let’s try and compartmentalize some of these competitor profiles for a deeper understanding and basic application in the real world.

The Competitor’s Motivations

As is helpful in analyzing many aspects of a business, it pays to look at top management.

In this case, by trying to understand the motivations of the individuals themselves, we can get a sense for what kinds of motivations or goals will permeate throughout the organization, which is likely to play out in the financials eventually.

One way is to look at the track record of the CEO and CFO.

If the CEO has a reputation and background of cutting the bloat of big companies to expand margins, it could be likely that staff reductions are on the horizon. Depending on the industry and specific company situation, this could be desired or not.

Similarly, if a CEO is a founder, he/she could have a deep emotional attachment to a particular business unit or project. In this case, perhaps an unprofitable operation could continue longer than what logic would normally dictate, which could put pressure on competitors with higher ROI requirements in the same market.

Looking at the CFO—is this person known to make lots of acquisitions or to reinvest internally in the business? Are share buybacks as part of capital allocation from a cash cow more likely instead (which could calm the waters and allow peers to profitably co-exist without aggressive market share stealing)?

The Actions of Competitors

But it’s not just personal background that’s important; after all, actions speak louder than words.

So, what major actions is management taking which could be telegraphing their intentions, and thus their long term strategy?

Is management consistently making large acquisitions at a very specifically targeted market, are they aggressively deploying resources or marketing spend to a particular unit, are they taking a loss leader approach in any particular market?

One example of this could be EA’s recent acquisition of Codemasters, wherein the company outbid Take Two Interactive’s original offer of $994M. This action could be seen as a direct attack against Take Two overall, or just an aggressive focus on expanding their product line past their established sports game genres and into a more competitive position in the racing game genre.

These are all valid questions to ask in an in-depth peer group analysis.

While you might not get all of the answers to these questions, even a few observations can go a long way to understanding why managers are doing what they are, and potentially foreseeing futures where competitors are co-existing profitably versus engaging in expensive market share battles.

More Peer Group Analysis Considerations

Of course nobody can analyze businesses perfectly, and there are many judgments involved when it comes to investing capital in them.

Getting into the shoes of management of a parent company, or conglomerate like Berkshire Hathaway or Johnson & Johnson, can be a fantastic way to get better perception on the business strategy for a particular business unit and its future path to success.

Again, it’s not a perfect method, but it can add a layer of confidence and conviction in management and the direction of the business—one not influenced by the manic swings of Mr. Market.

Here’s a few more things to consider…

  • Although capitalism is (generally) a zero sum game, where the big whales tend to swallow the small fish, mutual cooperation can exist. This can provide higher profitability and free cash flows for the competitors involved, rather than an all-out battle for market share. It also does happen from time to time in industries, which can be illustrated by long standing (and unspoken) oligopolies in which investors of all companies involved saw superior compounding of their capital.
  • A business can sometimes telegraph their general direction and competitive strategy by the ways they reinvest their cash flows. While some businesses might do this to a higher degree than others, it can provide a key insight into the company’s “aggressiveness” and strategy towards a market.
  • The “aggression” towards competitors can often happen during the formation of an industry, as participants clamor for market share and declare “battles” for pieces of that market—through their actions. This can take many forms: hostile takeovers, price cutting, imitation, etc.

Keep in mind that a lot of this market interaction between competitors is likely unspoken, and parallels other types of power plays which are unwritten but often observed. This is also not an all-inclusive list of the competitive forces behind a market and the actions of its participants, and I again recommend the Competitive Strategy book by Michael E. Porter for that.

Example: Microsoft and Intuit

Now for an example, as an application of these ideas…

Take a company like Microsoft, with a business unit that is a huge cash cow (the Windows suite of products). Looking at the segment performance of their cloud segment Azure, you see massive growth in revenues—and it’s likely a huge focus for the company. Being a huge focus means a good probability of allocating their best people, highest proportion of resources (reinvested capital), and highest actions of “aggression” towards the threat in that market.

A smaller company which directly competes with Microsoft is probably more likely to find success by finding a small niche to co-exist alongside Microsoft’s cash cow, rather than directly encroach on Azure.

That’s not to stay that Microsoft wouldn’t defend their cash cow were there a direct attack, but the company might be less likely to act with retaliation against a company which can co-exist with Microsoft’s cash cow without taking too much share.

An example of this might be Intuit’s TurboTax software.

I’m sure Microsoft could’ve focused resources to create an alternative, but with so many stakes in the fire maybe it saw better avenues of growth elsewhere.

Then in that sense, Intuit could have its own cash cow with TurboTax and be able to worry less about direct attacks from the behemoth that is Microsoft.

Contrast this to when Microsoft was much smaller and the software industry much more of a “wild, wild, west”, when the company went on an acquisition spree to secure software like the ones that eventually became Word and Excel.

This doesn’t just apply to technology companies too—you could look at all sorts of businesses and the ways they choose to allocate marketing dollars, product launches, and other investments to see similar business strategies playing out.

Investor Takeaway

What’s great about doing an in-depth, individual peer group analysis is that you can also use this process to intimately understand the inter-workings of the business you are evaluating itself as well.

As Porter puts it:

“Although the framework and questions presented here are stated in terms of competitors, the same ideas can also be turned around to provide a framework for self-analysis. The same concepts provide a company with a framework for probing its own position in its environment. And beyond this, going through such an exercise can help a company understand what conclusions its competitors are likely to draw about it. This is part of sophisticated competitor analysis because these conclusions shape a competitor’s assumptions and thus behavior, and are crucial to making competitive moves.”

Before I send you off on your way, I thought I’d provide a list briefly summarizing more of the questions that Porter asks about a company’s FUTURE GOALS:

  • What are the company’s recent financial results?
  • What generic strategy has the company had success with in the past?
  • How big is the potential role of synergy in relation to past actions?
  • What can we glean from the compensation structure?
  • Is there a dividend track record that takes priority?
  • Is there an explicit company vision or mission which hints at their strategy?
  • What types of people and experience is the board of directors comprised of?

Some of these questions and thoughts might be hard to quantify for the average investor looking from the outside in, and that’s okay.

What’s important is that in evaluating a competitive moat we are looking at the entire industry, and trying to put as many pieces together as we can to better understand the qualitative aspects of a business.

As it relates to analyzing the industry, or a company’s peers, also remember the importance of valuation.

Going back to the Microsoft example—a company with a stout competitive advantage over competitors in PC software displayed by decades of dominance and growth—the stock itself did not make for a good investment if purchased around its peak in 1999/2000.

Sure the stock has done great over the past 5 years, but investors experienced over a decade of flat stock performance at a time when the market performed much better, following its period of above average valuations before the dot com bust.

By combining a strong understanding of a company’s competitive position with a discipline to buy only at attractive valuations, you can get multiple drivers to push up the stock over the very long term (through growth and multiple expansion).

Having a deep understanding of a company’s peers and where they fit within those peers can give you the conviction to see a crashing stock price as an opportunity to buy more, rather than an ominous sign of a poor business model.

It’s those elements in stock analysis and investment which can lead to really fantastic returns over the very long term.