chapter sixteen industry analysis
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Cleary / Jones Investments: Analysis and Management. CHAPTER SIXTEEN Industry Analysis. Learning Objectives. To state the importance of industry analysis To explain how industries are classified To analyze the life cycle and qualitative factors that affect industries - PowerPoint PPT PresentationTRANSCRIPT
CHAPTER SIXTEEN Industry Analysis
Cleary / Jones Investments: Analysis and
Management
Learning ObjectivesLearning Objectives
To state the importance of industry To state the importance of industry analysisanalysis
To explain how industries are classifiedTo explain how industries are classified To analyze the life cycle and qualitative To analyze the life cycle and qualitative
factors that affect industriesfactors that affect industries To evaluate future industry prospects To evaluate future industry prospects
by analyzing the business cycleby analyzing the business cycle
Importance of Industry Importance of Industry AnalysisAnalysis
Second step in the fundamental Second step in the fundamental analysis of common stocksanalysis of common stocks– Industries promising the most opportunity Industries promising the most opportunity
in the future should be consideredin the future should be considered Concepts of industry analysis related Concepts of industry analysis related
to valuation principlesto valuation principles Continual analysis due to inconsistent Continual analysis due to inconsistent
industry performance over timeindustry performance over time
Industry Performance Over Industry Performance Over TimeTime
Potential value of industry analysis seen Potential value of industry analysis seen by assessing the performance of by assessing the performance of different industries over timedifferent industries over time– Year-end industry index prices for the TSE Year-end industry index prices for the TSE
300 Composite Index over a long time 300 Composite Index over a long time period shows industries perform differently period shows industries perform differently over timeover time
– Stock performance affected by industryStock performance affected by industry Industries in decline should be avoidedIndustries in decline should be avoided
Consistency of industry performanceConsistency of industry performance– Maintaining positions in growth industries Maintaining positions in growth industries
leads to better returnsleads to better returns Can industry performance be predicted Can industry performance be predicted
reliably on the basis of past success?reliably on the basis of past success?– Rankings inconsistent over timeRankings inconsistent over time– Industries with recent poor performance Industries with recent poor performance
should not be ignoredshould not be ignored
Industry Performance Over Industry Performance Over TimeTime
What is an Industry?What is an Industry?
Are industry classifications clear-cut?Are industry classifications clear-cut? Industries cannot be casually Industries cannot be casually
identified and classifiedidentified and classified– Diversified lines of business cause Diversified lines of business cause
classification problemsclassification problems– Industries continue to become more Industries continue to become more
mixed in their activities and less mixed in their activities and less identifiable with one product or serviceidentifiable with one product or service
Classifying IndustriesClassifying Industries TSE 300 Composite Index: 14 major industry TSE 300 Composite Index: 14 major industry
groups, 40 subgroupsgroups, 40 subgroups Standard Industrial Classification (SIC)Standard Industrial Classification (SIC)
– Based on census data and on the basis of what Based on census data and on the basis of what is producedis produced
– SIC codes have 11 divisions, A through KSIC codes have 11 divisions, A through K– Each division has several major industry groups, Each division has several major industry groups,
designated by a two-digit codedesignated by a two-digit code The larger the number of SIC digits, the more specific The larger the number of SIC digits, the more specific
the breakdownthe breakdown
Analyzing IndustriesAnalyzing Industries
By stage in their life cycleBy stage in their life cycle– Helps determine the health and future Helps determine the health and future
prospects of the industryprospects of the industry Pioneering stagePioneering stage
– Rapid growth in demandRapid growth in demand– Opportunities may attract other firms Opportunities may attract other firms
and venture capitalists and venture capitalists – Difficult to identify likely survivorsDifficult to identify likely survivors
Expansion stageExpansion stage– Survivors from the pioneering stage are Survivors from the pioneering stage are
identifiableidentifiable– Firm operations more stable, dependableFirm operations more stable, dependable– Considerable investment funds attractedConsiderable investment funds attracted– Financial policies firmly establishedFinancial policies firmly established– Dividends often become payableDividends often become payable
Attractive to a wide group of investorsAttractive to a wide group of investors
Analyzing IndustriesAnalyzing Industries
Stabilization (maturity) stageStabilization (maturity) stage– Growth begins to moderateGrowth begins to moderate– Marketplace is full of competitors Marketplace is full of competitors – Costs are stable rather than decreasingCosts are stable rather than decreasing
Limitations of life cycle approachLimitations of life cycle approach– A generalization that may not always applyA generalization that may not always apply– Tends to focus on sales, market share, and Tends to focus on sales, market share, and
investment in the industryinvestment in the industry
Analyzing IndustriesAnalyzing Industries
Analyzing IndustriesAnalyzing Industries Implications for stock pricesImplications for stock prices
– Function of expected returns and riskFunction of expected returns and risk Pioneering stage offers the highest Pioneering stage offers the highest
potential returns, greatest riskpotential returns, greatest risk Investors interested in capital gains should Investors interested in capital gains should
avoid maturity stageavoid maturity stage Expansion stage of most interest to Expansion stage of most interest to
investorsinvestors– Growth is rapid, but orderlyGrowth is rapid, but orderly
Qualitative AspectsQualitative Aspects
Historical performance Historical performance – Historical record of sales and earnings Historical record of sales and earnings
growth and price performance should be growth and price performance should be consideredconsidered
Although past cannot be simply extrapolated Although past cannot be simply extrapolated into the future, it does provide contextinto the future, it does provide context
Competitive conditions in industryCompetitive conditions in industry– Competition determines an industry’s Competition determines an industry’s
ability to sustain above-average returnsability to sustain above-average returns
Porter’s Competitive Porter’s Competitive FactorsFactors
Influences on return on investmentInfluences on return on investment– Threat of new entrantsThreat of new entrants– Bargaining power of buyersBargaining power of buyers– Rivalry between existing competitorsRivalry between existing competitors– Substitute products or services Substitute products or services – Bargaining power of suppliersBargaining power of suppliers
Industry profitability is a function of Industry profitability is a function of industry structureindustry structure
Qualitative AspectsQualitative Aspects Governmental effectsGovernmental effects
– Regulations and policies have significant Regulations and policies have significant effects on industrieseffects on industries
Structural changes in how economy Structural changes in how economy creates wealthcreates wealth– Canada continues to move from an industrial Canada continues to move from an industrial
to an information/communication societyto an information/communication society– Structural shifts can occur even within Structural shifts can occur even within
relatively new industriesrelatively new industries
Evaluating Future Industry Evaluating Future Industry ProspectsProspects
To forecast long-term industry To forecast long-term industry performance, investors should ask:performance, investors should ask:– Which industries are obvious candidates Which industries are obvious candidates
for growth and prosperity?for growth and prosperity?– Which industries appear likely to have Which industries appear likely to have
difficulties as Canada moves from an difficulties as Canada moves from an industrial to an information-based industrial to an information-based economy?economy?
Picking Industries for Picking Industries for Next YearNext Year
Which industries are likely to show Which industries are likely to show improving earnings? improving earnings? – Estimate expected earnings and earnings Estimate expected earnings and earnings
multiple for an industry; however, earnings multiple for an industry; however, earnings estimates are notoriously inaccurateestimates are notoriously inaccurate
Which industries are likely to show Which industries are likely to show improving P/E ratios?improving P/E ratios?– Investors tend to pay too much for favoured Investors tend to pay too much for favoured
companies in an industrycompanies in an industry
Likely direction of interest rates and Likely direction of interest rates and which industries are most affected which industries are most affected by a significant rate change should by a significant rate change should be consideredbe considered
Industries most affected by possible Industries most affected by possible political events, new technology, and political events, new technology, and inflation should also be consideredinflation should also be considered
Picking Industries for Picking Industries for Next YearNext Year
Business Cycle AnalysisBusiness Cycle Analysis Analysis of industries by their operating Analysis of industries by their operating
ability in relation to the economy as a ability in relation to the economy as a wholewhole– Some industries move closely with the Some industries move closely with the
business cycle, others do notbusiness cycle, others do not Growth industries Growth industries
– Earnings expected to be significantly above Earnings expected to be significantly above the average of all industriesthe average of all industries
Growth stocks suffer less during a recessionGrowth stocks suffer less during a recession
Defensive industriesDefensive industries– Least affected by recessions and Least affected by recessions and
economic adversityeconomic adversity Cyclical industriesCyclical industries
– Most affected by recessions and Most affected by recessions and economic adversityeconomic adversity
– ““Bought to be sold”Bought to be sold”– Counter-cyclical industries exist as wellCounter-cyclical industries exist as well
Business Cycle AnalysisBusiness Cycle Analysis
Interest-sensitive industriesInterest-sensitive industries– Particularly sensitive to expectations Particularly sensitive to expectations
about changes in interest ratesabout changes in interest rates Careful analysis of business cycle and Careful analysis of business cycle and
likely movements in interest rates likely movements in interest rates help make better buy/sell decisionshelp make better buy/sell decisions
Industry knowledge is valuable in Industry knowledge is valuable in selecting or avoiding industriesselecting or avoiding industries
Business Cycle AnalysisBusiness Cycle Analysis