The Impact Of Industry Classification On The Valuation Accuracy Of Multiples In The South African Capital Market

Abstract

Although multiples are used extensively in practice, empirical guidance in emerging markets is limited in this regard. In terms of valuation accuracy, the impact of peer group selection by way of industry classification in emerging markets has not yet been substantiated by research. This paper investigates the valuation performance of multiples over various industry classifications when valuing the equity of South African companies listed on the Johannesburg Stock Exchange for the period 2001 to 2010. The empirical results revealed that peer group selection based on a narrower industry classification could, on average, increase valuation accuracy by as much as 19.60%.

Precision, Consistency and Bias in Emerging Equity Markets

“…The harmonic mean is used since most researchers regard it as a viable and unbiased estimator (Dittman & Maug, 2008;Bhojraj & Lee, 2002;Liu et al, 2002b;Beatty et al, 1999). The sector industry classification is applied, since previous research established that it was the optimal industry classification when conducting a crosssection analysis (Nel et al, 2013a). The application of an industry-specific approach to multiples is well established by research (Nel et al, 2013a;Nel, 2009a, b;Goedhart, Koller & Wessels, 2005;Liu, Nissim & Thomas, 2002a;Fernández, 2001;Barker, 1999).…”

“…The sector industry classification is applied, since previous research established that it was the optimal industry classification when conducting a crosssection analysis (Nel et al, 2013a). The application of an industry-specific approach to multiples is well established by research (Nel et al, 2013a;Nel, 2009a, b;Goedhart, Koller & Wessels, 2005;Liu, Nissim & Thomas, 2002a;Fernández, 2001;Barker, 1999). (2) produces (3) for the calculation of the error margin (valuation error):…”

“…The initial analysis of the data indicated the presence of a significant number of outliers (Nel et al, 2013a;. Consequently, observations located outside of the 1 st and 99 th percentiles of the pooled observations were removed.…”

An Optimal Peer Group Selection Strategy for Multiples-Based Modelling in the South African Equity Market

“…Peer group selection is a key consideration when performing multiples-based valuations (Fuller and Kerr, 1981;Lang and Stulz, 1992;Fenn and Cole, 1994;Eberhart, 2001;Bhojraj and Lee, 2002;Nel, Bruwer and Le Roux, 2013a, b). Despite the lack of theoretical guidance on peer group selection in emerging markets, there are two schools of thought in this regard (Bhojraj and Lee, 2002).…”

“…Despite the lack of theoretical guidance on peer group selection in emerging markets, there are two schools of thought in this regard (Bhojraj and Lee, 2002). The first school of thought argues that peer group selection should be based on industry classification (Alford, 1992;Damodaran, 2006a;Nel et al, 2013a, b). The premise of the proponents of industry classification as a basis for peer group selection is that companies operating in similar industries will have similar profitability, growth and risk profiles.…”