ECONOMIC AND
INDUSTRY ANALYSIS
PERTEMUAN 9-10
Questions
What are the generic approaches to security
analysis?
What are the components of gross domestic
product (GDP), and what can they tell us
about industry prospects?
How do international economic factors affect
the U.S. economy?
What are the major determinants of an
economy’s long-term growth?
Questions
What are the primary influences
affecting the short-term growth of an
economy?
What indicators can be used to forecast
economic variables?
What is expectational analysis?
How is the stock market related to
economic activity?
Questions
Why must an analyst review both cyclical
change and structural change when
analyzing an industry?
What are the five basic competitive forces
that determine the intensity of competition in
an industry and, thus, its rate of return on
capital?
What is the industrial life cycle and its
stages?
Economic Analysis and
Efficient Markets
If markets are efficient,
should we bother with
analysis?
Yes! In fact, in an
efficient market, likely
the only way to
outperform market
averages is to forecast
the future better than
the consensus.
General Approaches to
Security Analysis
Two basic approaches:
Emphasize history, looking for trends
 Focusing on the future

Still look at some historical information, but
focus on looking forward to future trends
 Top-down approach
 Bottom-up approach

General Approaches to
Security Analysis
Top-Down Approach (Our focus)
1.
2.
3.
Review the macro-economy
Analyze different industries and sectors
Determine buy/sell candidates
Bottom-up Approach

Focus primarily on the firm-specific
factors that will lead to success,
regardless of industry or macroeconomic
factors
A Three-Step Process
Within the three-step process of the top-down
approach, all steps are crucial
General economic influences

Government policies strongly influence the
economic environment, leading to profound effects
on industries
Market analysis


We can see the influence of changes in the overall
economy on various classes of investments
Some investments do better than others before,
during, and after recessions, for instance
A Three-Step Process
Industry Influences


We seek to determine which industries will likely
do better than others in the expected economic
environment
Also, changing demographic factors have different
effects across industries
Company Analysis


Individual investments will either make or break
portfolio performance
Once well-positioned industries are determined,
find well-positioned firms within those industries
A Three-Step Process
There is academic support for this top-down
approach



Most changes in individual earnings related to
changes in aggregate earnings and changes in a
firm’s industry
There is a relationship between stock and bond
prices and macroeconomic variables
Rates of return for individual stocks can be
explained by the aggregate stock market and the
firm’s industry
A Three-Step Process
Bottoms up to the top
down approach! It
works!
A Quick Review of
Economic Concepts
Domestic Economic Activity
Forecasting trends in major economic
variables such as GDP, inflation, interest
rates
GDP (Gross Domestic Product) components




Consumption spending
Investment spending
Government expenditures
Export and import activity
A Quick Review of
Economic Concepts
Domestic Economic Activity
Domestic Economic Policies

Monetary policy





Policies of the Fed to control the money supply and
thereby affect the overall economy
Open market operations
Discount rate changes
Reserve requirement changes
Fiscal policy

Government taxing and spending policies to influence
the economy and pursue other public interests
A Quick Review of
Economic Concepts
The Global Economy
Domestic firms impacted by global
competition and a global business
environment
The health of foreign economies impacts
domestic firms who export
Trade impacted by exchange rates

Exchange rates impacted by relative interest
rates, inflation rates, and real economic growth
within a country and across countries
Economic and Security
Market Influences
As we forecast economic growth, a number of
factors will influence our expectations
Influences on Long-term Expectations






Technology
Population
Labor force participation
Productivity
Resource availability
Incentives to expand
Economic and Security
Market Influences
Influences on Short-term Expectations









Influences caused by fluctuations in demand
Liquidity and bank lending
Monetary policy
Inflation
Interest rates
International influences
Consumer sentiment
Tax and other fiscal policy
Economic “shocks”
Industry Analysis
Many stock research firms organized
analysts by industry grouping

Industry-specific expertise is valuable
Industry: a set of businesses that
produce similar products used by
customers for similar purposes
Sometimes useful to use various
industry numerical classifications
Links Between the
Economy and Industries
Economic trends affect industry performance
Economic trends:

Cyclical changes




Ups and down of the business cycle
Different industries experience unique results depending
on the point within the business cycle
May call for a “rotation” strategy
Structural changes


Changes in government institutions, regulatory
environment, changes in technology, many more
Need to anticipate structural changes and analyze the
likely impact on various industries
The Stock Market and
the Business Basic
Cycle
Industries
Excel
Consumer
Durables
Excel
Financial
Stocks Excel
trough
peak
Capital
Goods Excel
Consumer
Stapes Excel
Structural Influences
In addition to economic changes, various
other trends also represent structural
influences that will having varying effects
across industries

Social Influences






Demographics: baby boom and beyond
Lifestyles: changing definition of “traditional”
Social values: environment, alcohol, tobacco
Technology
Politics and Regulation
Theme Investing
Competitive Structure of
an Industry
Porter’s competitive forces are factors that
determine a firm’s competitive environment

Rivalry among existing competitors


Threat of new entrants



Are there barriers to entry?
Threat of substitute products
Bargaining power of buyers


Both price-based and non-price-based competition
Volume discounts, quality demands
Bargaining power of suppliers

Can suppliers increase prices or reduce quality?
Industry Life Cycle
Another tool: 5-stage industry life cycle model:
1.
Pioneering development

2.
After marketing or technological breakthrough
Rapidly accelerating industry growth
Market develops, strong demand, new entrants
3.
Mature industry growth
Growth starts to flatten
4.
Stabilization and market maturity
Growth matches industry growth
5.
Deceleration of growth and decline
Declining profits, some losses, exit from industry
Conducting an Industry
Analysis
Common problem: paralysis of analysis

Lots of data with no defined way of looking at it
Solution: get organized



Define the industry
Determine who is in the industry
Identify and investigate the leading competitors



Read annual reports, industry publications
Collect other relevant data from SEC filings, published
information
Field interviews with management, customers, etc.