Industry Analysis Once we have done a thorough economic analysis, we ask the question “which industries will benefit most from the upcoming economic environment?” This will lead to several industries, and our analysis will lead us to choose the one that we find to be best positioned.
What is an Industry?
An industry is a group of companies which produce similar goods and/or services. Until recently (and often still), industries were classified by Standardized Industrial Classification (SIC) codes, but this was replaced by the North American Industry Classification System (NAICS, http:// www.census.gov/epcd/www/naics.html) which is much more detailed than SIC. SIC codes were 4-digit, while the NAICS uses 6 digits for a much finer, and more useful, breakdown of industries. NAICS will also facilitate comparisons of companies in the US, Canada, and Mexico (it was developed by all three countries for this purpose).
Business Cycles
Business Cycle: The
recurring pattern of recession and recovery. The economy recurrently experiences periods of expansion and contraction but the length and depth of those cycles can be different. The transition points across cycles are called peaks and troughs A peak is the transition from the end of an expansion to the start of a contraction A trough occurs at the bottom of a recession just as the economy enters a recovery
Business Cycles (Continued) • Presents graphs of several measures of production and output. •Threre is a generally rising trend with variations. •The bottom graph of capacity utilization shows a cyclical pattern. •Shaded areas show recessions.
Business Cycles (Continued)
Cyclical vs Defensive Industries Cyclical
industries are the ones that show aboveaverage sensitivity to the business cycle, state of the economy. High beta stocks Defensive industries are the ones that show little sensitiviy to the business cycle. Low beta stocks Choose cyclical industries when you are optimistic about the economy and choose defensive industries when you are pessimistic about the economy.
Business Cycles (Continued)
Economic Indicators Set
of cyclical indicators helps to forecast, measure, and interpret short-term fluctuations in economic activity. These indicators can be divided into three general groups as leading, coincident and lagging. Leading indicators tend to rise and fall in advance of the economy. Examples: average weekly hours of production workers, stock prices Coincident indicators tend to change directly with the economy Examples: industrial production, manufacturing and trade sales
Business Cycles (Continued) Lagging
indicators tend to follow the lag economic performance. Examples: ratio of trade inventories to sales
Components/Key Characteristics of Industry Analysis
The purpose of industry analysis is to identify which industries will be good for investors in the upcoming environment. Your textbook has an excellent discussion of 9 issues that should be addressed:
Competitive Structure Permanence Phase of Life Cycle (Industry Life Cycle) Vulnerability to External Shocks Regulatory and Tax Conditions / Government Attitude towards Industry Labor Conditions Historical Financial Performance / Past Sales and Earning Performance Financial and Financing Issues Industry Stock Price Valuation / Industry share price relative to industry earnings
Competitive Structure
Some of the questions to be answered are: What
companies are in the industry? What are their market shares? Which are publicly traded? Has the number of competitors been rising, fallen, or remained stable?
Permanence
Some of the questions to be answered are: Is
the industry likely to survive in the longrun? Are there any major technological threats (such as laser printer was to the dot matrix printer)? Are there regulatory threats?
Phase of Life Cycle
Some of the questions to be answered are: Where
is the industry in its life cycle? The best returns and most risk tend to occur early in the cycle. The possible phases are: Birth Phase / Pioneering Stage / Start-up Growth Phase / Expansion Stage / Consolidation Mature Growth Phase / Maturity Stabilization or Decline Phase / Relative Decline
Industry Analysis (Continued)
Vulnerability to External Shocks
Some of the questions to be answered are: Could
major portions of the industry be nationalized by foreign governments? Are they dependent on supplies of key commodities (such as oil)? Are they subject to external political whims? (South Africa’s gold industry suffered when Apartheid became an international issue.) Are they subject to fashion trends that may soon change?
Regulatory and Tax Conditions
Some of the questions to be answered are: What
are the current regulations that the industry faces? Are there likely to be new regulations? Are the industry’s products subject to special taxes (such as “sin taxes” on alcohol and tobacco products or the “windfall profits” tax on oil companies in the 1970’s)? Are there special tax breaks offered to the industry?
Labor Conditions
Some of the questions to be answered are: What
percentage of the industry’s workers are unionized? Are the unions generally hostile or complacent? Is unionization increasing or decreasing? Are qualified workers easily obtainable, or are they difficult to find? This has been a particular problem for the high-tech industries.
Historical Financial Performance Some of the questions to be answered are: What
is the historical record of industry revenue, earnings and dividends? Are these financial variables cyclical, countercyclical? Have they been growing slowly, rapidly, or about average? What is the average cost structure in the industry? Heavy on fixed costs? Or, are variable costs the lion’s share?
Financial and Financing Issues
Some of the questions to be answered are: How
much debt does the average firm have? What is the mix between fixed assets and current assets? Is it labor intensive or capital intensive? What is the average age of the fixed assets? Will they have to be replaced soon?
Industry Stock Price Valuation
Some of the questions to be answered are: What
is the historical average P/E for the industry? How high has it been? What were the economic conditions when the highs were hit? How low has it been? What were the economic conditions when the lows were hit? Where is it now? Where should it be, based on historical economic comparisons? What kinds of capital gains and dividend yields have historically been generated?
Sources of Industry Information
The primary sources of industry-wide information are trade groups, for example (Trade Publications):
Semiconductor Industry Association (http://www.semichips.org/) Wards (automobiles, http://www.wardsauto.com/) Electronics Industry Association (http://www.eia.org/) Software Publishers Association (http://www.spa.org/)
There are also many trade magazines that may, or may not, be published by the trade associations (Forbes). Additionally, Value Line Investment Survey (http:// www.valueline.com/) publishes an analysis of each of the industries that they cover (The Value Line). Finally, research analysts at brokerage firms often provide reports on the industries that they cover (S&P).