BM410: Investments

Industry Analysis: Global and Country

Or understanding the critical industry factors that affect your company

BM410: Investments

Objectives

A. Understand the critical areas of the global analysis framework, particularly industry analysis

B. Understand how to include industry forecasts into your company report

C. Understand where to find sources of data for your international and domestic industry prospects

D. Review an example of an analysis of an industry, and understand the required format of your Industry Report

A. Understand the Critical Areas of the Global Analysis Industry Framework

1. Global Industry Analysis• Key Considerations?• What are the key trends globally which have or will

have an effect on the industry- What has been happening in global markets that

can or may have an effect on my market and company?

- What are the likely key trends in technology, production, sales, etc. that can or may affect the industry?

- Who are the potential international competitors who can or may enter my market?

2. Country Industry Analysis

Key considerations?• I. Industry life cycles

• What is the sensitivity of company earnings to business cycles?

• Key factors to analyze• Sensitivity of sales of the firm’s product

to the business cycles• Operating leverage• Financial leverage

• II. Industry competitiveness models • Porter’s 5 Forces• SWOT Analysis

I. Industry Life Cycles

All industries are in different stages of development!You must determine at which stage your industry is

in currentlyRemember that technological innovation may have

the effect of changing the life cycle of the industry

Stage Sales GrowthStart-up Rapid & IncreasingConsolidation StableMaturity SlowingRelative Decline Minimal or Negative

Industry Life Cycles

Stage 1 Stage 2 Stage 3 Stage 4 Start-up Consolidation Maturity Decline

Beginning Rapid Stabilization and Deceleration

Development Growth Market Maturity of Growth

Bryan’s View of Industry and Management

Good Poor

Good Do ??

Well

Poor ?? Poor

Industry

Management Quality

B. How to Include Industry Forecasts in your Company Report

How do you include industry data in your report?Generally, through industry competitiveness models

What is the purpose of these models, i.e. strategic analysis?• Industries, like companies, can be evaluated in a

consistent format to determine its attractiveness• The key is to develop/use a consistent format

that will help you understand the key drivers of profitability in the industry

• Once you have identified the key drivers of industry profitability, then you evaluate your company on those key drivers.

Choice of Industry Competitiveness Models

Does it matter which model of competitiveness you choose?• While the choice of model and the model

format may differ, the key is to understand the key factors driving all areas of the industry to determine the relative attractiveness of the industry

Industry Competitiveness Models – SWOT Analysis

Strengths• What are the positives for the industry, i.e. what

factors make this industry attractive short-term? Weaknesses

• What factors make this industry unattractive, particularly in the short-term?

Opportunities/Trends• What factors make this industry likely to do well in

the future? Threats

• What factors are most likely to make this industry unattractive in the future?

II. Industry Competitive Models – Porter Model

New Entrants

Industry

Suppliers Competitors Buyers

Substitutes

Determinants of Industry Profitability

Industry Structure• 1. Industry Competitors - rivalry• 2. Potential Entrants – threats • 3. Suppliers – bargaining power• 4. Buyers – bargaining power• 5. Substitutes – threats

The strength of these forces is a function the industry structure

Industry Profitability (continued)

The collective strength of these 5 areas affects a firms ability to earn returns in excess of their cost of capital• If the forces are positive, firms can earn

good rates of return• If not, despite good management, firms may

have difficulty earning good returns

1. Industry Competitors

Rivalry Determinants• Industry growth

• Fixed (or storage costs) / value added

• Intermittent overcapacity

• Product differences

• Brand identity

• Switching costs

•Concentration and balance

•Informational complexity

•Diversity of competitors

•Corporate stakes

•Exit barriers

2. Potential Entrants

Entry Barriers• Economies of scale• Proprietary product differences• Brand identity• Switching Costs

3. Suppliers

Determinants of Supplier Power• Differentiation of inputs• Switching costs of

suppliers• Presence of substitute

inputs• Supplier concentration• Importance of volume to

supplier• Cost relative to total

purchases in industry

•Threat of forward integration to threat of backward integration •Capital requirements•Access to distribution•Absolute cost advantages•Government policy•Expected retaliation

4. Substitutes

Determinants of Substitutions Threat• Relative price performance of substitutes• Switching costs• Buyer propensity for substitutes

5. Buyers

Determinants of Buyer PowerBargaining leverage• Buyer concentration versus

firm concentration• Buyer volume• Buyer switching costs versus

firm switching costs• Buyer information• Ability to backward

integrate• Substitute products

•Price Sensitivity•Price to total purchases•Product differences•Brand identity•Impact on quality / performance•Buyer profits•Decision maker’s incentives

C. Sources of Data for Industry Analysis

Where is the best place to start? (see CR-FD-• Company 10K reports

• Companies are required by law to disclose information relating to what is happening in the industry (i.e. risk factors) and to a degree how they are doing relative to these events.

• Generally, the larger and better run companies will have a good description on the factors affecting the industry

• Look in the reports of other similar companies as well

Sources of Data (continued)

• BYU Library: Business and Company Resource Center (see FR FD-1A – Finding Key Sources of Financial Information)

• Go to [www.BYU.edu], [Libraries], [Harold B. Lee Library], [Find Articles], the click on the “Find Articles by Subject.” Select [Business]. There is a lot of information. Look for “Business and Company Resource Center.” Click on the [connect] link. Proceed through the first screen and select the “Business and Company Resource Center with PROMT and Investext Plus”. Enter your company or industry name and hit Search. You will be brought into a screen that has company profile, news/magazines, histories, investment reports, financials, rankings, suits and claims, products, industry overview,

and associations.

Sources of Data (continued)

• Bloomberg: • Type IBQ [go]. This will give you a list of the

50+ industries, Select an industry and hit [go]. This gives a few pages of information on the industry selected

• Value-line (from the BYU Library): • At the beginning of each industry section, there

is a short description of the industry, the key drivers, and what is happening domestically.

Sources of Data (continued)

Other sources:• US Government, including the Commerce

department

• Sell-side research, i.e. Merrill, Morgan Stanley, Schwab, etc.

• Multilateral government institutions, i.e. the World Bank and International Monetary Fund

D. Understand Required Areas of your Industry Report

10 Required Key Areas:1. General Industry Information2. Industry Type3. Key Indices4. Recommendation5. Description and Summary6. Competitive Structure7. Competitiveness Analysis Model8. Key Valuation Ratios to Watch9. Key Items to Watch10. Relative Performance versus the market and economy

General Industry Information

This section includes three areas:Narrow industry classification

This is the specific industry you are concerned with—the industry in which your company operates, i.e. Computer Hardware

Broad industry classification

This is the broader industry classification for your industry, i.e., Computers

Country

This is the country of domocile of your company, i.e., the United States for Apple

2. Industry Type

I use the 6 industry types proposed by Peter Lynch. Each of these general types of industries/firms possess

different characteristics, so investors need to focus on different attributes to determine if the industry/firm is attractive or not. Slow GrowersStalwartsFast GrowersCyclicalsTurnaroundsAsset Plays

Slow Growers

Slow growers: UtilitiesAt or near the top of the industry or product life

cycleTypically pay a regular dividend due to few

attractive internal investments Focus on:

Potentially profitable new products or acquisitions that will allow rising earnings and dividends

Repositioning of products along the life cycle

Stalwarts

Stalwarts: Pharmaceuticals Expected to have faster earnings growth, but their

consistent growth, priced into the stock price, makes large price changes unlikely

Tend to do relatively better in times of uncertainty due to a flight to quality and liquidity

Focus on:The firm’s current PE versus its history with the

market and industryAnything that might increase the firm’s earnings

growth rate

Fast Growers

Fast Growers: technologyComprised of smaller aggressive firms with high

earnings growth potential (>20% year)Risky as stock prices tumble at first sign of

negative earnings surprises Focus on:

How will the firm sustain its high growth rate?How will this growth be financed? Is it maintaining its cash flow growth?

Cyclicals

Cyclicals: automotive, building constructionFirms whose sales and profits rise and fall with the

business cycle Focus on:

Economic forecasts and where we are currentlyThe firm’s internal conditions, managementTheir financial ability to weather economic

downturnsNote: Watch for when earnings begin to rise after an

economic downturn. Although its PE will be high, this is the best time to buy (assuming your economic forecasts are correct)

Turnarounds

Turnarounds: Industries in transition• Firms with current internal weaknesses but external

opportunities which investors believe they can recover from

• Due to typically high leverage and investor pessimism, these generally are risky investments but can be profitable investments if you get them right

Focus on:• The firm’s specific plans to correct the problem/or

hire new management with turnaround experience• Discussions with firm’s suppliers/customers

may provide information on the success and timing of a turnaround

Asset Plays

Asset plays: • Firm’s with valuable assets that are hidden

in the balance sheet, i.e. land holdings, film libraries, trademarks, patents, or subscribers

Focus on:• The value (intrinsic) of each major division

(or specific assets) on a stand-along basis. Compare this to the current market price of the firm

3. Key Indices

Here you pick the two best indices which best represent the industry you are analyzing.An easy way to determine which industry indices

to use would be to go to Bloomberg, type your company symbol [equity] [go], “DES” [go], then page down. You will see which indices your company is included in.

Check your indices to determine what information is available, i.e., price, PE, dividend, etc.

Generally, you want indices in which the major companies in your industry are included

In the case of the Computer Industry, I chose the AMEX Computer Technology Index (it has price and PE data).

4. Recommendation

This is where you put your reputation on the line and state your recommendationThis is where you determine, strategically, whether

this industry is a buy, hold, or sell.Remember that you can have an attractive

company in an unattractive industry, and an unattractive company in an attractive industry. This is just your assessment of the industry.

I consider the Computer Hardware Industry a hold, as it is fast becoming a commodity/appliance type product. Unless a manufacturer can differentiate their

product, it will be difficult to maintain the higher margins necessary for profitability

5. Description and Summary

This is a short description and summary of the industry Include a short but broad description to help the

reader understand the industry In addition, include one or two key points of your

analysis to support your recommendation from #4 above.

In the Computer Hardward Industry, I discuss a short description of the industry and the key areas included. Then I review the key issues supporting my “hold” recommendation, mainly the evolution of the industry and the challenges it faces.

6. Competitive Structure

Your competitive structure would include:Number of players in the industrySize of the various playersKey items critical to the industry, i.e. drivers of

profitabilityAmount of international versus domestic

competition The computer industry is characterized by a few

manufactures that produce internationally, particulalry in emerging markets as labor costs are critical. In addition, I discuss the key areas of maintaining profitability in the industry, i.e. Service and support.

7. Competitive Analysis Model

You get to choose your competitive analysis modelTwo most familiar are the SWOT analysis and

Porters 5 forces. Other models are available and can be used. The choice is yoursThe most important key is that you cover all the

important areas of industry analysis. In the Computer Hardware Industry example, I used

the SWOT framework which looked at both the short-term and long-term analysis. Key was the ability to specify the key drivers of profitability and key drivers of risk.

8. Key Valuation Ratios to Watch

Here you tell what you consider are the most important valuations ratios to watch.Think through what are the key drivers of

profitability for the industryPick the ratios that best show differences in

those key driversRemember that these ratios will differ by

industry (and often country as well). Look in specific sell-side reearch for key ratios that are emphasized (see TT01)

Key in the Computer industry is profitability. As such, PE and PB are important. In addition, some companies have high levels of cash, so you must ensure earnings are from operations and not interest.

9. Key Items to Watch

Here is what you should watched for this industryAs you understand the key drivers of the industry,

try to understand key items to watch that allow you to understand what is happening in the industry.

In the Computer Industry, a key item is the Book to Bill ratio. This measures industry new orders (new orders booked), to billing (orders where they have requested payment).

• When this ratio is greater (less) than 1.0, it is assumed that the industry is expanding (contracting).

• Note that there are book to bill ratios in many of the major countries, i.e., Japan, Taiwan, etc.).

10. Relative Performance versus the Market and Economy

This section shows how the industry has performed versus a major market index (of your choice) and versus economic growthWhile this is more important for more mature industries,

it can be helpful for all industries as it gives a historical snapshot of performance versus specific benchmarks.

Relative Performance versus the S&P 500 (in percent %): 00 01 02 03 04

05 YTDXCI 29.5 81.7 75.2 -35.0 -14.9 -12.4SPX 33.1 28.3 20.9 -9.0 -11.9 -3.9Relative -3.6 53.4 54.3 -26.0 -3.0 -8.5GDP 4.3 4.6 4.2 4.1 1.1 1.0

Note: GDP data are from Teaching Tool FR-CR-1A Industrial Example - AAPL

Questions

Any questions on the format of the analysis I require for your Industry Report?

Review of Objectives

A. Do you understand the critical areas of the global analysis framework, particularly industry analysis?

B. Do you understand how to include industry forecasts into your company report?

C. Do you understand where to find sources of data for your international and domestic industry prospects?

D. Did you understand the example of an analysis of an industry, and the required areas of your industry report?