Many investors utilise a technique known as relative valuation to assess what the fair value for a stock may be.
This is certainly a reasonable approach to use considering the market often gets the valuation of a company roughly right.
When undertaking relative (also known as comparative) valuation there are a number of approaches. Arguably the most common is to compare companies based on their respective price-to-earnings (PE) multiples.
This assessment requires benchmarking. Generally, a peer group or index will be selected for comparison against. This will be either as selected by the analyst, based on industry, a review of similar companies on global exchanges, or compared with an index average.
In the case of AMP Limited (ASX: AMP), what applicable benchmark to use is debatable.
Officially, AMP is classified as an insurance stock. This means that the stock is grouped together with other insurance companies such as Insurance Australia Group Ltd (ASX: IAG) and QBE Insurance Group Ltd (ASX: QBE).
A review of AMP's full year results for the year ending December 2015 show that the group's insurance operations only accounted for approximately 27% of overall group profits after tax.
Alternatively, AMP also operates a bank so it could be considered reasonable to benchmark against fellow ASX-listed bank shares. However, AMP's banking operations only account for around 10% of group profit so this industry wouldn't appear to be the most appropriate benchmark to use either.
Indeed, when most people think about AMP these days they no doubt are more likely to consider the group's financial advisory or superannuation services.
Another comparison an investor could choose to make would be against a market average such as the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO). The problem here is that a general index arguably fails to adequately account for the group's insurance and banking operations. Although these two combined operations accounting for less than half of AMP's total profits nevertheless carry certain risks, which need to be fully incorporated into a valuation of the stock.
A fourth option is to build your own set of peers to compare against. A list such as this would more than likely include Macquarie Group Ltd (ASX: MQG) and IOOF Holdings Limited (ASX: IFL). This approach could bring your analysis closer to the mark but may still require further adjustment to take into account the risks associated with operating an insurance and banking business.
