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Accounting Research Center, Booth School of Business, University of Chicago

Who Is My Peer? A Valuation-Based Approach to the Selection of Comparable Firms Author(s): Sanjeev Bhojraj and Charles M. C. Lee Source: Journal of Accounting Research, Vol. 40, No. 2, Studies on Accounting, Entrepreneurship and E-Commerce (May, 2002), pp. 407-439 Published by: Blackwell Publishing on behalf of Accounting Research Center, Booth School of Business, University of Chicago Stable URL: http://www.jstor.org/stable/3542390 . Accessed: 15/01/2011 08:35 Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at . http://www.jstor.org/action/showPublisher?publisherCode=black. . Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.

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Research Journalof Accounting Vol.40 No. 2 May2002 in Printed U.S.A.

Who Is My Peer? A Valuation-Based Approach to the Selection of Comparable Firms SANJEEV BHOJRAJ AND CHARLES M. C. LEE* Received4January2001;accepted4 September2001

ABSTRACT This study presents a general approach for selecting comparable firms in market-based research and equity valuation. Guided by valuation theory, we develop a "warrantedmultiple" for each firm, and identify peer firms as those having the closest warranted multiple. We test this approach by examining the efficacy of the selected comparable firms in predicting future (one- to three-year-ahead) enterprise-value-to-sales and price-to-book ratios. Our tests encompass the general universe of stocks as well as a sub-population of socalled "new economy" stocks. We conclude that comparable firms selected in this manner offer sharp improvements over comparable firms selected on the basis of other techniques.

1. Introduction
Accounting-based market multiples are easily the most common technique in equity valuation. These multiples are ubiquitous in the reports and recommendations of sell-side financial analysts, and are widely used in

*Johnson Graduate School of Management, Cornell University. We thank Bhaskaran Swaminathan, as well as workshop participants at the Australian Graduate School of ManConferagement, Cornell University, Indiana University, the 2001 Journal ofAccountingResearch ence, the 2001 HKUST Summer Symposium, Syracuse University, and an anonymous referee, for helpful comments. The data on analyst earnings forecasts are provided by I/B/E/S International Inc. 407 of of 2002 Copyright University Chicagoon behalfof the Institute Professional Accounting, ?,

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S. BHOJRAJ C. M. C. LEE AND

investment bankers' fairness opinions (e.g., DeAngelo [1990]). They also appear in valuations associated with initial public offerings (IPOs), leveraged buyout transactions, seasoned equity offerings (SEOs), and other merger and acquisition (M&A) activities.' Even advocates of projected discounted cash flow (DCF)...
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