Comparing two stocks sounds simple: pick the one that looks better. In practice, most comparisons are unfair. The companies differ in size, sector, debt and reporting, and the figures are often taken at different dates or measured in different ways. A fair comparison matches the things that should be matched, uses the same measures for both, and asks what would have to be true for one to be the better choice.
This guide gives you a checklist for a fair comparison and walks through an example. It does not tell you which company to buy. It shows you how to test the question.
Start with the question
What are you comparing them for? Maybe you want to know which company is cheaper for its profit. Maybe you want the more stable business, or the one with better growth. The question determines the measures. Comparing valuation needs valuation measures, and comparing stability needs debt and earnings consistency.
Write the question down, then choose measures that answer it. A comparison of many measures without a question tends to end with whichever company has more favourable numbers on the measures you happened to pick.
Match like with like
Before you compare any figure, make sure the companies are comparable.
Sector. A bank and a software company have different economics. Their debt, margins and valuation levels are not meant to be compared directly. Compare each company with peers in its own sector.
Size. A large company and a small one can differ in liquidity, risk and the level of information available. Compare companies in a similar size band, or be clear that you are comparing across sizes.
Currency and market. Companies in different markets can report in different currencies and follow different accounting rules. Convert figures carefully, and check that the reporting standards are similar.
Time frame. Compare the same period. Trailing figures for one company and forecast figures for the other is a common mistake.
Fiscal year. Companies with different year-end dates report on different schedules. Line up the periods before comparing growth rates.
A checklist of measures
Choose a small set of measures, and use the same ones for both companies.
- Valuation: P/E, price-to-book, dividend yield, or enterprise value to operating profit.
- Profitability: operating margin, net margin, return on equity.
- Growth: revenue and profit growth over several years, not one year.
- Financial strength: debt relative to equity or to earnings, and interest cover.
- Cash: operating cash flow compared with profit.
- Trading: average daily volume and the bid-ask spread, to judge how easily you can buy and sell.
- Risk: how much the price has moved in the past, and how concentrated the shareholding is.
Each measure has a limit. Read the guides on the P/E ratio and the bid-ask spread for the detail on those.
Worked example
Suppose you want to compare two companies in the same sector, both listed in the same market, both reporting in the same currency, and both with a financial year ending in March. Call them Company A and Company B.
| Measure | Company A | Company B | Note |
|---|---|---|---|
| Share price | 120 | 60 | Price alone does not show size |
| Shares outstanding | 50 million | 150 million | |
| Market cap | 6 billion | 9 billion | B is larger |
| P/E (trailing) | 12 | 18 | A looks cheaper |
| Revenue growth, 3-year average | 6% | 14% | B is growing faster |
| Operating margin | 15% | 10% | A is more profitable |
| Debt to equity | 0.4 | 1.1 | A has less debt |
| Operating cash flow vs profit | 95% | 60% | A converts profit to cash |
| Average daily volume | 2 million | 500,000 | A trades more easily |
The table gives a picture, not an answer. Company A looks cheaper, more profitable, less indebted and more liquid. Company B is growing faster, and its price is higher partly because it is bigger. Which is the better choice depends on what you value.
Asking the right follow-up questions
A fair comparison ends with questions, not a verdict. For this example, you might ask the following.
Why does B grow faster? Is it taking market share, buying other businesses, or benefiting from a temporary trend? If it is buying growth, the debt and the price of those acquisitions matter.
Why is A's margin higher? Is it a better business, or does it have a different product mix that will not last?
Is B's higher P/E justified by its growth? A higher P/E can be sensible if the growth continues. Check whether the growth is likely to slow.
What does the debt do to B's risk? With a debt-to-equity of 1.1, a fall in profit could strain the balance sheet more than it would strain A's.
Which company is more exposed to the market? Check how each share has moved in past downturns, and how concentrated the shareholding is.
Keep the comparison honest
A common trap is to choose the measures after you have chosen the company you like. Decide the measures and their weights before you look at the numbers, and write them down. If you change the measures, say why.
Another trap is to compare one company's best year with the other's average year. Compare like with like over the same period.
Finally, remember that a comparison tells you about the past and the present. The future for each company depends on things the figures do not show: management, competition, regulation and the economy.
Compare the trend, not one year
A single year can mislead in either direction. A company can have a strong year because of an unusual sale, a weak harvest in its competitor's region or a one-off tax refund. Look at the same measures over at least three to five years. Ask whether the margin is stable, whether growth comes from volume or price, and whether the debt has risen steadily or jumped in one period.
A trend also shows whether a company's advantage is holding. A higher margin that is shrinking each year is a different story from a lower margin that is rising. The direction often tells you more than the level.
Compare against a benchmark
Compare each company with a benchmark as well as with each other. A sector index, the broader market or a basket of close peers shows whether a company's returns came from its own performance or from the tide that lifted the whole group. If both companies beat the market, the question is which one did so more consistently. If both lagged, the question is whether either has a reason to recover.
Checklist
- Write down the question you are answering.
- Confirm the companies are in the same sector, size band, market and reporting period.
- Choose a small set of measures, and write down how you will weigh them.
- Calculate each measure for both companies, from the same source and date.
- Ask why each difference exists before you decide which company is better.
- Check the trading liquidity and the risk before any decision.
Key takeaways
A fair comparison of two stocks matches sector, size, market, currency and time period, and it uses the same measures for both. Choose the measures to answer a clear question, write down how you will weigh them, and calculate them from the same source and date. A table of numbers gives you a picture, but the real work is asking why the differences exist. A comparison is an input to a decision, not the decision.
This guide is for general information, not financial advice. See the disclaimer.