Economic, Industry and Company Analysis

Some Guidelines
（ Chapter 12, 13, 14, 18)

–Economic Analysis
–Industry Analysis
–Company Analysis
Stock Valuation
Bond Valuation
 Economic and Industry Analysis
• B.F. King in an article published in the Journal
of Business (1966) observed that on the
average over half the variation in a stock’s
price could he attributed to a market influence
that affects al stock-market indexes, such as
the Dow Jones Industrial Average or the S&P
500 Stock Index.

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 Economic and Industry Analysis
• Stocks are also subject to an industry
influence, over and above the influence
common to all stocks. King noted that this
industry influence explained, on the average,
about 13 percent of the variation in a stock’s
price.

• In sum about two-thirds of the variation in the

prices of stocks observed in King’s study was
the result of market and industry influences or
factors.

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 ECONOMIC ANALYSIS

ECONOMIC FORECASTING AND THE STOCK-INVESTMENT

DECISION

FORECASTING TECHNIQUES
Short-Term versus Long-Term Economic Forecasts

Alternative Techniques of Short Term Business Forecasting

1. Anticipatory Surveys
2. Barometric or Indicator Approach
3. Money and Stock Price
4. Econometric Model Building
5. Opportunistic Model Building
 2. Barometric or Indicator Approach
Leading Indicators

Those time series of data that historically reach their high points
(peaks) or their low points (troughs) in advance of total
economic activity;
• Average weekly hours of production workers (manufacturing)

• Average weekly initial claims for unemployment insurance

• Manufacturers new orders (consumer goods and materials

industries)

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 2. Barometric or Indicator Approach
Leading Indicators
• Vendor performance—slower deliveries diffusion index

• Contracts and orders for plant and equipment

• New private housing units authorized by local building

permits
• Change in manufacturers’ unfilled orders (durable goods
industries)
• Change in sensitive materials prices

• Stock prices. 500 common stocks

• Money supply (M2)

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 2. Barometric or Indicator Approach
Coincident Indicators

The roughly coincident indicators reach their peaks or

troughs at approximately the same time as the
economy.

• Employees on nonagricultural payrolls

• Personal income less transfer payments
• Industrial production
• Manufacturing and trade sales

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 2. Barometric or Indicator Approach
Lagging Indicators

The lagging indicators reach their turning points after the

economy has already reached its own.

• Average duration of unemployment

• Ratio of trade inventories to sales
• Change in index of labor cost per unit of output
• Average prime rate charged by banks
• Commercial and industrial loans outstanding
• Ratio of consumer instalment credit outstanding to
personal income
• Change in consumer price index for services
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 ECONOMIC ANALYSIS
• International Economic Factors
• Disposable Income Demographic Factors and
Demand
• Other Economic Factors
– Physical Infrastructure
– Rate of Interest (bank rate, interest of savings, rate
on commercial loans)
– Inflation
– Availability of Finance
– Availability of Energy and Price

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 The Relationship between
GDP, NDP, NI, PI and DI
Income Method
Measures US$
1 Gross Domestic Product (GDP-at Market Price)
Less: Consumption of Fixed Capital (Dep n)
2 Net Domestic Product (NDP at Market Price)
Less: Indirect Business Taxes
3 Net Domestic Product (NDP at Factor Cost)
(+/-) Net Factor Income from Abroad
4 National Income (NI)
Less: Social Security Contributions
Less: Corporate Income Tax
Less: Undistributed Corporate Income
Add: Transfer Payments
5 Personal Income (PI)
Less: Personal Taxes
6 Disposable Income (DI)
 INDUSTRY ANALYSIS (IA)
• Introduction
• Industry – Definition and Classification
• Key Characteristics in an Industry Analysis
• Industry Life Cycle (ILC)
• International Investment
• Sources of Information for IA
• Other Observations

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 INDUSTRY ANALYSIS
INTRODUCTION

When the economic outlook is assessed, along with

the direction of changes in the overall market for
stocks, the analyst must realize that even though
industry groups and/or individual companies may find
it difficult to “buck the trend”. For the analyst, industry
analysis demands insight into:

a. the key sectors or subdivisions of overall economic

activity that influence particular industries, and
b. the relative strength or weakness of particular
industries other grouping under specific sets of
assumptions about economic activity.
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 INDUSTRY ANALYSIS
INDUSTRY – DEFINITION AND CLASSIFICATION

Webster’s Dictionary defines an industry as -

‘a department or branch of a craft, art, business, or
manufacture.’

And more specifically -

• A group of productive or profit-making enterprises or
organizations that have a similar technological
structure of production and that produce or supply
technically substitutable goods, services, or sources of
income.
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 INDUSTRY ANALYSIS
Classification
• By Product
• Standard Industrial Classification (SIC)
• Classification According to Business Cycle
– growth
– cyclical
– defensive, and
– cyclical-growth.

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 Standard Industrial Classification (SIC)

Industrial Division Major Groups

A Agriculture, forestry, and fishing 01—09
B Mining 10—14
C Construction 15—17
D Manufacturing 20—39
E Transportation, Communications, 40—49
electric, gas. and sanitary services
F Wholesale trade—durable goods 50—51
G Retail trade 52—59
H Finance, insurance, and real estate 60—67
I Services 70—89
J Public administration 91—97
K Nonclassifiable establishments 99
 INDUSTRY ANALYSIS
• KEY CHARACTERISTICS IN AN INDUSTRY
ANALYSIS
– Past Sales and Earnings Performance
– Permanence
– The Attitude of Government toward the
Industry
– Labor Conditions
– Competitive Conditions

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 INDUSTRY ANALYSIS
INDUSTRY LIFE CYCLE
The life of an industry can be separated into
– the pioneering stage
– the expansion stage
– the stagnation stage, and
– the decay stage.

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 Industry Life Cycle

4-18
 Phases of Business Cycle

Peak
Peak
Peak
Rec
ry
ve

Rec
e
co

ssi o G DP
GDP
Re

Average

ry

e
ssi o
ve
n
co Line
Re

n
Trough Trough
Trough

Time
 INDUSTRY ANALYSIS
• INTERNATIONAL INVESTMENT
• SOURCES OF INFORMATION FOR INDUSTRY
ANALYSIS
• OTHER OBSERVATIONS ON INDUSTRY ANALYSIS
– composition of the industry’s population
– distribution of income and wealth among the
population
– any evolving buying habits of consumers, and
– foreign and domestic production competition.

4-20
 Analysis of Investments and
Management of Portfolios
by
by Keith
Keith C.
C. Brown
Brown && Frank
Frank K.
K. Reilly
Reilly

Company Analysis &

Stock Valuation

–Economic, Industry, and Structural Links

Chapter 14

to Company Analysis
–Company Analysis
Economic, Industry, and Structural Links to
Company Analysis
• Company analysis is the final step in the top-
down approach to investing
• Macroeconomic analysis identifies industries
expected to offer attractive returns in the
expected future environment
• Analysis of firms in selected industries
concentrates on a stock’s intrinsic value based
on growth and risk

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 Economic and Industry Influences
• If trends are favorable for an industry, the
company analysis should focus on firms in
that industry that are positioned to benefit
from the economic trends
• Firms with sales or earnings particularly
sensitive to macroeconomic variables should
also be considered
• Research analysts need to be familiar with
the cash flow and risk of the firms

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 Structural Influences
• Social trends, technology, political, and regulatory
influences can have significant influence on firms
• Firms can grow and succeed despite unfavorable
industry or economic conditions due to
demographic changes or shifts in consumer tastes
and lifestyles
• Early stages in an industry’s life cycle see changes
in technology which followers may imitate and
benefit from
• Politics and regulatory events can create
opportunities even when economic influences are
weak
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Company Analysis and Stock Valuation

• Good companies are not necessarily good

investments
• Compare the intrinsic value of a stock to its
market value
• Stock of a great company may be overpriced
• Stock of a growth company may not be growth
stock

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 Growth Companies
• Growth companies have historically been
defined as companies that consistently
experience above-average increases in sales
and earnings
• Financial theorists define a growth company
as one with management and opportunities
that yield rates of return greater than the firm’s
required rate of return

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 Growth Stocks
• Growth stocks are not necessarily shares in
growth companies
• A growth stock has a higher rate of return than
other stocks with similar risk
• Superior risk-adjusted rate of return occurs
because of market undervaluation compared
to other stocks

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 Defensive Companies and Stocks
• Defensive Companies
– The firms whose future earnings are more likely to
withstand an economic downturn
– Low business risk
– No excessive financial risk
– Typical examples are public utilities or grocery
chains—firms that supply basic consumer
necessities
• Defense Stocks
– The rate of return is not expected to decline or
decline less than the overall market decline
– Stocks with low or negative systematic risk
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 Cyclical Companies and Stocks
• Cyclical Companies
– They are the companies whose sales and earnings
will be heavily influenced by aggregate business
activity
– Examples would be firms in the steel, auto, or
heavy machinery industries.
• Cyclical Stocks
– They will have greater changes in rates of return
than the overall market rates of return
– They would be stocks that have high betas.

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 Speculative Companies and Stocks
• Speculative Companies
– They are the firms whose assets involve great risk
but those that also have a possibility of great gain
– A good example of a speculative firm is one
involved in oil exploration
• Speculative Stocks
– Stocks possess a high probability of low or
negative rates of return and a low probability of
normal or high rates of return
– For example, an excellent growth company whose
stock is selling at an extremely high P/E ratio

14-30
 Company Analysis
• Firm’s Overall Strategic Approach
– Industry competitive environment
– SWOT analysis
• Strengths
• Weaknesses
• Opportunities
• Threats
• Firm’s Valuation Approaches
– Present value of cash flows
– Relative valuation ratio techniques
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 Firm Competitive Strategies
• Defensive strategy involves positioning firm so
that it its capabilities provide the best means to
deflect the effect of competitive forces in the
industry
• Offensive strategy involves using the
company’s strength to affect the competitive
industry forces, thus improving the firm’s
relative industry position

14-32
 Firm Competitive Strategies
• Michael Porter (1980) suggests two major strategies:
– Low-Cost Strategy
• The firm seeks to be the low-cost producer, and hence
the cost leader in its industry
• Cost advantages vary by industry and might include
economies of scale, proprietary technology, or
preferential access to raw materials
– Differentiation Strategy
• Firm positions itself as unique in the industry in an area
that is important to buyers
• A company can attempt to differentiate itself based
on its distribution system or some unique marketing
approach
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 Focusing a Strategy
• Select segments in the industry
• Tailor strategy to serve those specific groups
• Determine which strategy a firm is pursuing
and its success
• Evaluate the firm’s competitive strategy over
time
• See Exhibit 14.1

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 Exhibit 14.1

14-35
 SWOT Analysis
• Internal Analysis
– Strengths
• Give the firm a comparative advantage in the
marketplace
• Perceived strengths can include good customer
service, high-quality products, strong brand
• image, customer loyalty, innovative R&D, market
leadership, or strong financial resources
– Weaknesses
• Weaknesses result when competitors have
potentially exploitable advantages over the firm

14-36
 SWOT Analysis
• External Analysis
– Opportunities
• These are environmental factors that favor the firm
• They may include a growing market for the firm’s
products (domestic and international), shrinking
competition, favorable exchange rate shifts, or
identification of a new market or product segment
– Threats
• They are environmental factors that can hinder the
firm in achieving its goals
• Examples would include a slowing domestic
economy, additional government regulation, an
increase in industry competition, threats of entry, etc
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 Tenets of Warren Buffet
• Business Tenets
– Is the business simple and understandable?
– Does the business have a consistent operating
history?
– Does the business have favorable long-term
prospects?
• Management Tenets
– Is management rational?
– Is management candid with its shareholders?
– Does management resist the institutional
imperative?
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 Tenets of Warren Buffet
• Financial Tenets
– Focus on return on equity, not earnings per share
– Calculate “owner earnings” （ which is equal to
the free cash flow after capital expenditures)
– Look for companies with high profit margins
– For every dollar retained, make sure the company
has created at least one dollar of market value
• Market Tenets
– What is the intrinsic value of the business?
– Can the business be purchased at a significant
discount to its fundamental intrinsic value?
14-39
 BBC’s Interview with Mr. Warren Buffet

http://www.dailymotion.com/video/x1cdq6a

4-40
 Bitcoins
Bitcoin was invented by an unknown person or group of
people under the name Satoshi Nakamoto and released
as open-source software in 2008. Bitcoins are created as
a reward for a process known as mining. They can be
exchanged for other currencies, products, and services.
A total of 21 million units of bitcoin have been circulated
for mining.
(Wikipedia, 2017)

https://www.youtube.com/watch?v=L-Qhv8kLESY

http://fortune.com/2018/01/10/bitcoin-warren-buffett-cryptocurrency/