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 above-
average 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)

 Laggingindicators 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 long-
run?
 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, counter-
cyclical?
 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).