Using Peer Firm Information/Relationships to Rank Stocks

Are the industry membership of a firm, as designated by Standard Industrial Classification (SIC) code, and the position of the firm within its industry good predictors of the performance of its stock? In their May 2024 paper entitled “Decoding Cross-Stock Predictability: Peer Strength versus Firm-Peer Disparities”, Doron Avramov, Shuyi Ge, Shaoran Li and Oliver Linton devise the following two industry related stock metrics and test their abilities to predict stock returns:

1. Peer Index (PI) – calculated for each firm via a multi-input, inception-to-date regression to predict next-month stock return, replacing firm characteristics by the contemporaneous average values for all firms in its industry as inputs.
2. Peer-Deviation Index (PDI) – calculated for each firm via a multi-input, inception-to-date regression to predict next-month stock return using firm characteristics minus the contemporaneous average values of these characteristics for all firms in its industry as inputs (indicating the standing of the firm within its industry).

Inputs consist of 94 firm-specific characteristics and 8 industry-related characteristics, organized into six groups: momentum, value versus growth, investment, profitability, trading frictions and intangibles. Using monthly values for the selected 102 firm/industry characteristics and monthly returns for common stocks in the top 80% of AMEX/NYSE/NASDAQ  market capitalizations during January 1980 through March 2022, they find that: (more…)