Economic and Industry Analysis Co Combined 9-2010

7/31/2019 Economic and Industry Analysis Co Combined 9-2010

1/62

Economic and Industry

Analysis

Combined from various files

9-2010


2/62

Fundamental Analysis

Approach to Fundamental Analysis:

Domestic and global economic analysis

Industry analysis

Company analysis

Why use the top-down approach?

Framework of Analysis


3/62

Performance in countries and regions ishighly variable.

Political risk

Exchange rate risk

Sales

Profits

Stock returns

Global EconomicConsiderations


4/62

Table 17.1 Economic Performancein Selected Emerging Markets


5/62

Gross domestic product Unemployment rates

Interest rates & inflation

Budget deficit

Consumer sentiment

Key Economic Variables


6/62

Fiscal Policy- government spending andtaxing actions.

Direct policy

Slowly implemented

Federal Government Policy


7/62

Monetary Policy- manipulation of themoney supply to influence economic

activity. Initial & feedback effects

Tools of monetary policy

Open market operations

Discount rate

Reserve requirements

Supply Side Policies

Federal Government Policy(contd)


8/62

Figure 17.10 A stylized Depiction ofthe Business Cycle


9/62

Cyclical Economic Factors

Inflation

Interest rates

International economics

Consumer sentiment


10/62

Cyclical Indicator Approach toForecasting the Economy

National Bureau of EconomicResearch (NBER)

Cyclical indicator categories leading indicators

coincident indicators

lagging indicators Composite series and ratio of series


11/62

Figure 17.3 Cyclical Indicators


12/62

Table 17.2 Indexes of EconomicIndicators


13/62

Figure 17.4 Indexes of Leading,Coincident, and Lagging Indicators


14/62

Table 17.3 Economic Calendar


15/62

Figure 17.5 Economic Calendarat Yahoo!


16/62

Monetary Variables, theEconomy, and Stock Prices

Money supply and the economy Money supply and stock prices

Excess liquidity and stock prices year to year percentage change in M2

money supply adjusted for small timedeposits less the year-to-year percentage

change in nominal GDP


17/62

Monetary Variables, theEconomy, and Stock Prices

Other economic variables and stockprices growth in industrial production

changes in the risk premium twists in the yield curve

measures of unanticipated inflation

changes in expected inflation duringperiods of volatile inflation


18/62

Inflation, Interest Rates, andSecurity Prices

Inflation and interest rates generally move together

investors are not good at predicting

inflation Inflation rates and bond prices

negative relationship

more effect on longer term bonds Interest rates and stock prices

not direct and not consistent

effect varies over time


19/62

Structural Economic Changesand Alternative Industries

Social Influences

Demographics

Lifestyles

Technology

Politics and regulations

Economic reasoning, Fairness, Regulatorychanges affect industries, Taxation

Globalizationand its effects oninternational politics and commerce


20/62

Theme Investing

Based on identifying emerging trends,such as:

Technology

Aging population

Freer trade and developing-country

growth Identification of themes provides insight

into industry analysis


21/62

The Stock Market andthe Business Cycle

Exhibit 14.2


22/62


Exhibit 14.2

trough

peak


23/62


Exhibit 14.2

FinancialStocks Excel

trough

peakConsumerDurables

Excel

CapitalGoods Excel

BasicIndustries

Excel

ConsumerStaples Excel


24/62

Links Between the Economyand Industry Sectors

Identify and monitor key assumptions andvariables

Economic trends are either

Cyclical - up and down with business cycle Structural - major change

Combined changes have implications for the

industry being analyzed Switching from one industry group to another

over the course of a business cycle is known

as a rotation strategy


25/62

Sector Rotation

Portfolio is adjusted by selectingcompanies that should perform well for thestage of the business cycle

Peaks natural resource extraction firms

Contraction defensive industries such aspharmaceuticals and food

Trough capital goods industries Expansion cyclical industries such as

consumer durables


26/62

Industry Analysis

The second step in the three-stepfundamental analysis procedure

In the first step (chapter 14) we

discussed the macroanalysis of thestock market

The last step will analyze individual

companies and stocks


27/62

Sensitivity to business cycles Factors affecting sensitivity of earnings to

business cycles: Sensitivity of sales of the firms product to

the business cycles Operating leverage Financial leverage

Industry life cycles

Industry Analysis


28/62

Stage Sales Growth

Start-up Rapid & Increasing

Consolidation Stable

Maturity Slowing

Relative Decline Minimal or Negative

Industry Life Cycles


29/62

Figure 17.11 The Industry LifeCycle


30/62

Life Cycle-Sales and Profits


31/62

Market Share and cost


32/62

Analysis of Industry Competition

Competition and Expected IndustryReturns Porters concept of competitive strategy is

described as the search by a firm for afavorable competitive position in an industry

To create a profitable competitive strategy, afirm must first examine the basic competitive

structure of its industry The potential profitability of a firm is heavily

influenced by the profitability of its industry


33/62

Forces DrivingIndustry Competition


34/62


35/62

ent y ng an


36/62

ent y ng anSelecting Competitive

Strategies Five conditions affecting the competitivestructure and profits of an industry

1. Current rivalry

2. Threat of new entrants

3. Potential substitutes

4. Bargaining power of suppliers

5. Bargaining power of buyers


37/62

Porter's Competitive Strategies

Low-Cost Strategy

The firm seeks to be thelow-costproducer, and hence thecost leaderin its industry

Differentiation Strategy

firm positions itself as unique in theindustry


38/62

Select one or several segments in theindustry to which it tailors its strategy.

Firms Questions?

Do unique cost or need opportunities exists?

Are they are being served by another firm?

Can they be priced to generate abnormal

returns to the firm?

Focusing a Strategy


39/62

Analysts Questions?

Which strategy is being pursued?

Is the firm successful?

Are strategies are being sustained?

Does strategy need to be changed?

Focusing a Strategy


40/62

Company Analysis


41/62

SWOT Analysis

Examination of a firms:

Strengths

WeaknessesOpportunities

Threats


42/62

SWOT Analysis


Strengths


Threats

INTERNAL ANALYSIS


43/62

SWOT Analysis


Strengths


Threats EXTERNAL ANALYSIS


44/62

Measures of Value-Added

Consider economic profit

NPV in capital budgeting

Uses

Measure management performance

Indicators of future returns

Economic Value-Added (EVA)

Market Value-Added (MVA)

C t i i C i


45/62

Categorizing Companies-Lynch

1. Slow growers

2. Stalwart

3. Fast growers

4. Cyclicals

5. Turnarounds6. Asset plays


46/62

Peter Lynchs Stock Types

1. Slow grower grows with GDP- Dividendyield, not PE

2. Stalwarts- they grow faster (10-12%) than aslow grower, but not fast- PE ratio important

3. Fast grower, 20-25% growth --Lynchratio=g/PE>1.0 Must understand theproduct.

4. Turnaround-battered, depressed, HIGH RISK5. Asset Plays-value that Wall Street does not

recognize

6. Cyclical-timing is everything two decision


47/62

Favorable Attributes of Firms

1. Firms product is not faddish

2. Company has competitive advantage overrivals

3. Industry or product has potential formarket stability

4. Firm can benefit from cost reductions

5. Firm is buying back its own shares ormanagers (insiders) are buying


48/62

Tenets of Warren Buffet

Business Tenets

Management Tenets

Financial Tenets

Market Tenets


49/62

Business Tenets

Is the business simple andunderstandable?

Does the business have a consistent

operating history?

Does the business have favorable long-term prospects?


50/62

Management Tenets

Is management rational in allocationcapital?

Is management candid with with its

shareholders?

Does management resist the institutionalimperative? Does management just do

what others are doing or do they think andact independently?


51/62

Financial Tenets

Focus on return on equity, not earningsper share

Calculate owner earnings including the

effects on cash flow of capitalexpenditures

Look for companies with high profitmargins

For every dollar retained, make sure thecompany has created at least one dollar ofmarket value


52/62

Market Tenets

INTRINSIC VALUE---What is the value ofthe business?

MARGIN OF SAFETY---Can the business

be purchased at a significant discount toits fundamental intrinsic value?


53/62

Growth Rate Estimates

Compound Average Historical DividendGrowth Rate (or use PV and FV and I/Y)

Sustainable Growth Rate = RR X ROE

1D

Dn

0

n


54/62

An Alternate Measure of Growthg = (RR)(ROIC)

where:

RR = the average retention rate

ROIC = EBIT (1-Tax Rate)/Total Capital


55/62

Analysis of Growth Companies Generating rates of return greater than the

firms cost of capital is considered to be

temporary

Earnings higher the required rate of returnare pure profits

How long can they earn these excess

profits?

Is the stock properly valued?

Measures of Value Added


56/62

Measures of Value-Addedpage 593

The Franchise Factor Breaks P/E into two components

P/E based on ongoing business (base P/E)

Franchise P/E the market assigns to the expectedvalue of new and profitable business opportunities

Franchise P/E = Observed P/E - Base P/EIncremental Franchise P/E = Franchise Factor X Growth

Factor=((IRR k) / (ROE x k)) x (PV new growth projects/PV firm)

G

rk

kR


57/62

Growth Duration

Evaluate the high P/E ratio by relating P/Eratio to the firms rate and duration of

growth T model (see p 594)

P/E is function of

expected rate of growth of earnings per share

stocks required rate of return

firms dividend-payout ratio


58/62

Intra-Industry Analysis Directly compare two firms in the same

industry An alternative use of T to determine a

reasonable P/E ratio

Factors to consider A major difference in the risk involved

Inaccurate growth estimates

Stock with a low P/E relative to its growthrate is undervalued

Stock with high P/E and a low growth rate

is overvalued

Site Visits and the


59/62

Site Visits and theArt of the Interview

Focus on managements plans, strategies,

and concerns

Restrictions on nonpublic information

What if questions can help gaugesensitivity of revenues, costs, andearnings

Management may indicateappropriateness of earnings estimates

Discuss the industrys major issues

Review the planning process

Talk to more than ust the to mana ers


60/62

Influences on Analysts

Investment bankers may push forfavorable evaluations

Corporate officers may try to convince

analysts

Analyst must maintain independence andhave confidence in his or her analysis


61/62

When to Sell

Holding a stock too long may lead to lowerreturns than expected

If stocks decline right after purchase, is that a

further buying opportunity or an indication ofincorrect analysis?

Continuously monitor key assumptions

Evaluate closely when market valueapproaches estimated intrinsic value

Know why you bought it and watch for that to

change


62/62

Efficient Markets

Opportunities are mostly among less well-known companies

To outperform the market you must find

disparities between stock values and marketprices - and you must be correct

Concentrate on identifying what is wrong with

the market consensus and what earningsurprises may exist

Documents

Economic and Industry Analysis Co Combined 9-2010