Chapter Six
Industry Analysis
1
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Industry Life Cycles
are created because of economic growth, competition,
availability of resources, and the resultant market saturation…
Stage I: Development
Just getting started . . .
 Stage II: Growth
Acceptance, profits, increasing growth
 Stage III: Expansion
Sales, earnings grow at decreasing rate
 Stage IV: Maturity
Sales grow only as GDP does, market saturated
 Stage V: Decline

Sales decline at destructive innovation occurs
Logarithmic scale
Sales ($)
I
II
III
IV
Time
V
& Consider Individual Company Growth
Even In Mature Industries
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3
Real World of Investing
In Analyzing an Industry or Company, What’s a Brand Name Worth?

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A brand name can be worth
as much as brick and mortar
Business Week (BW) now publishes a list
of the 100 most valuable brand names in
the world and their value*
Interbrand Corp. measured this value for
BW: the present value of the future
impact of the power to increase sales and
earnings from brand name recognition
*”The Best Global Brands,” Business Week, August 6,
4
2001, pp. 50-55.
Real World of Investing
In Analyzing an Industry or Company, What’s a Brand Name Worth?
Worth of Brand Name =
The
Present Future
Value of Impact
The
Power to Increase
Sales and Earnings
From
Brand Name Recognition
5
Real World of Investing
In Analyzing an Industry or Company, What’s a Brand Name Worth?
Top Ten Firms in Business Week’s
Survey of the Best Global Brands*
(in billions of dollars)
Coca-Cola
$70.4
Nokia
$29.4
Microsoft
65.2
Disney
28.0
IBM
51.8
McDonald’s
24.7
GE
42.3
Marboro
22.1
Intel
31.1
Mercedes
21.3
*”The Best Global Brands,” Business Week, August 6, 2001, pp. 50-55.
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Real World of Investing
In Analyzing an Industry or Company, What’s a Brand Name Worth?
Value of Top Ranked Brand Names in Two Industries
Where Brand Name Recognition Is Particularly Important
(in billions of dollars)
Automotive
Mercedes
Technology
$21.3
IBM
$51.8
Toyota
20.8
Intel
31.1
Ford
17.1
HP
19.9
Honda
15.6
Cisco
15.8
BMW
15.1
Oracle
11.3
*”The Best Global Brands,” Business Week, August 6, 2001, pp. 50-55.
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Development – Stage I




Companies getting started
with a new idea,
product
or production technique
that makes them unique
Usually privately owned
financed with owner’s money
and with capital from
friends, family, and/or a bank
If successful,
may attract venture capital
Pays no dividends because needs any profits to
reinvest in new productive assets
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Growth– Stage II

An industry or company
that has achieved market acceptance
for its products or services

Retains earnings for reinvestment
Sales and returns on assets growing
at an increasing rate
Becomes profitable
Pays stock dividends to preserve capital
May pay low cash dividends as time passes




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Expansion– Stage III

Sales and earnings continue to expand
but at a decreasing rate
as competition fights for market share

Asset expansion slows
Firms more able to pay cash dividends
Stock dividends and splits still common
Dividend payout usually increases
from 5 – 15 to 25 – 30 percent of earnings



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Maturity– Stage IV




Industry grows only as overall economy
does
Plant and equipment are in place
Financing alternatives (both domestic and
international) and the cash flow from
operations are sufficient to meet growth
requirements of firms
Dividends may range from 40 – 50 percent
of earnings
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Decline– Stage V

Industries suffer declines in sales
if product innovation
has not increased product base
over the years

May be specific to a country
Industry may undergo consolidation
Dividend payout ratios often rise to 100%
or more of earnings, followed by cuts or
elimination of dividends


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Growth in Non-growth Industries



Growth companies may exist
even in a mature industry
Not all firms experience same growth path in
sales, earnings, and dividends
Some firms
•
•
•
•

Are better managed
Have better people
Have more efficient assets
Invest more in productive research and development
creating new or improved products
Some mature firms might be good investments
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Industry Structure
• Helps determine potential profitability of firms
• May induce special considerations such as
government regulation that positively or negatively
impact the firms and industry
• Determines whether cost advantages and product
quality create a dominant company within the
industry
•
•
Economic Structure
Competitive Structure
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Industry – Economic Structure


Monopolistic Competition – many small
firms, some product differentiation
Pure Competition – many firms, none
significant in size, no product
differentiation
• not widely found in the United States
• companies compete intensely, try to create
perceived differences in product quality or
service
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Industry – Economic Structure
determines how companies compete

Monopolies – single firm is the whole
industry
• Not common in United States except as public
utilities
• Regulations tend to limit growth and profitability
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Industry – Economic Structure

determines how companies compete
Oligopolies – few firms in open rivalry
• Quite common in large, mature U.S.
industries
• Such as autos, steel, oil, airlines, and
aluminum
• Competition between firms can be intense
• Profitability may suffer from price wars and
fights over market share
• Increasingly face international competition
altering their strategies
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Industry – Economic Structure
determines how companies compete


Monopolistic Competition – many small
firms, some product differentiation
Pure Competition – many firms, none
significant in size, no product differentiation
• Not widely found in the United States
• Companies compete intensely, try to create
perceived differences in product quality or
service
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Industry – Competitive Structure
Porter’s five forces
1.Threat of entry by new competitors
2. Threat of substitute goods
3. Bargaining power of buyers
4. Bargaining power of suppliers
5. Rivalry among existing competitors
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Pharmaceutical Industry
- An Example


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Relatively stable
Individual firms go thru cycles as patents expire
on popular drugs
Test of sustainability is firm’s R&D capability to
generate new products and get FDA approval
Mergers have led to large firms
International regulation, price controls, and HMO
bargaining power have been problems
Relatively low but fluctuating long-term debt to
equity ratios in many cases
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Table 6-6 Dow Jones Industrial Groups
Overview
•Basic Materials
•Consumer, Cyclical
•Consumer, Noncyclical
•Energy
•Financial
•Health Care
•Industrial
•Technology
•Telecommunications
•Utilities
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Table 6-6 Dow Jones Industrial Groups
•Basic Materials
• Chemicals
• Chemicals, commodity
• Chemicals, specialty
• Forest products
• Paper products
• Aluminum
• Mining, diversified
• Other nonferrous (e.g., aluminum)
• Precious metals
• Steel
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Table 6-6 Dow Jones Industrial Groups
•Consumer, Cyclical
Advertising
 Broadcasting
 Publishing
 Auto manufacturing
 Auto parts

Casinos
 Entertainment
 Recreation products and
services
 Restaurants
 Toys
 Home construction

Furnishings
 Retailers
 Retailers, apparel
 Retailers, broadline
 Retailers, drugbased
 Retailers, specialty
 Clothing and fabrics
 Footwear

Airlines
Lodging

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Table 6-6 Dow Jones Industrial Groups
•Consumer, Noncyclical
Consumer
services
 Distillers and
brewers
 Food products

Soft drinks
 Cosmetics and
personal
care

Food retailer &
wholesalers
 Consumer products

Household products,
durables
 Household products,
 Tobacco

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Table 6-6 Dow Jones Industrial Groups
•Energy
Coal
 Oil and gas
 Oil, drilling


Oil, integrated majors
Oil, secondary
 Oilfield
equipment
and services
 Pipelines

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Table 6-6 Dow Jones Industrial Groups
•Financial
Banks
 Insurance, composite
Specialty finance
 Real estate
investment
 Insurance, full line
 Financial
services,
 Insurance, life
diversified
 Insurance, property and
casualty
 Securities
brokers
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Table 6-6 Dow Jones Industrial Groups
•Health Care
Health care providers
 Medical products
Pharmaceutical
and
biotech
 Biotechnology


Advanced medical
devices
 Medical supplies


Pharmaceuticals
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Table 6-6 Dow Jones Industrial Groups
•Industrial
Aerospace and defense
 Building materials
 Heavy construction
 Containers and packaging
 Industrial diversified
 Industrial equipment
 Advanced industrial
equipment
 Electronic components and
equipment


Factory equipment
Heavy machinery
 Industrial services
 Pollution control and
waste management
 Industrial transportation
 Air freight and couriers
 Marine transportation

Railroads
 Trucking
 Transportation
equipment
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Table 6-6 Dow Jones Industrial Groups
•Technology
Hardware and
equipment
 Communications
technology
Computers


Office equipment
Semiconductor and
related
 Software

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Table 6-6 Dow Jones Industrial Groups
•Telecommunications
Fixed line
communications
 Wireless
communications

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Table 6-6 Dow Jones Industrial Groups
•Utilities
Electric
 Gas
 Water
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Pharmaceutical Industry
Government Regulation
•
•
•
•
These companies sell their products
throughout the world
Are regulated by governments across the
globe
The U.S. Food and Drug Administration (FDA)
is considered one of the most risk-averse and
strict enforcement agencies in the world
Quite often, drugs are approved for use in
other countries before being approved for sale
in the United States by the FDA
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Industry Groups and
Rotational Investment
Rotational investment refers to the
practice of moving in and out of
various industries over the business
cycle to benefit from economic
changes
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Pharmaceutical Industry
Research and Development
•
Uniquely important in this industry is the large
amounts of money invested in research and
development (R&D)
• Benchmark is the ratio of dollars spent on R&D
as a proportion of sales
• Small firms are at a disadvantage because of
their limited funds to devote to R&D and thus
their drug pipeline
• With only a 3.3% success in passing FDA
approval much R&D is spent on failures but a
success can reap large profits for a firm
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Pharmaceutical Industry
Other issues:
•
Product Diversity
•
It is unusual to find more than three drugs with
high market share treating the same problem
•
Usually one or two drugs dominate the market
Value of a pharmaceutical company is
influenced more by the potential “blockbuster”
drugs in the pipeline than current drugs that
may come off their patent protection in the
next few years
•
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Pharmaceutical Industry
Other issues:
•
Patents and Generic Drugs
•
U.S. Patent Office issues patents that
protect drugs from competition for a limited
number of years
•
After a patent runs out, generic copies
reduce profitability
•
Global patent protection is an important
issue because many countries violate or do
not enforce international patents
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Pharmaceutical Industry
Other issues continued:
•
Demographics and Managed Care
• As the world population ages, the demand for
drugs will grow
• The drive to restrain the rise in drug prices
through both managed care and government
programs will put downward pressure on profit
margins
• New Medicare drug coverage may create
enough of an increased demand to
compensate for possible pricing constraints
imposed on the pharmaceutical industry
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Pharmaceutical Industry
Other issues continued:
•
It pays to keep up-to-date on this or any
other industry you are interested in
analyzing by referring to Standard & Poor’s
Industry Surveys
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Summary

Industry analysis is the second step
in the top-down valuation process
• Used to predict potential growth rate in sales, earnings,
and cash flow
• Position of a firm on its life-cycle curve suggests how
fast a company can grow
• Iife-cycle approach to an industry includes:
1. Development, 2. Growth, 3. Expansion,
4. Maturity, and 5. Decline
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Summary

Industry structure and competition:
• Monopoly, oligopoly, & pure competition
structures affect pricing & returns
• Government regulation affects many
industry’s profits, product quality, energy
consumption, transportation and education
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Summary

Industry structure and competition:
• International competition, supply and
demand relationships, availability of raw
materials, and energy costs among other
things also must be observed
• The pharmaceutical industry was given
special attention because of its important
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WEBSITE
www.hoovers.com
COMMENTS
Provides limited free
information about sectors
and industries.
cbs.marketwatch.com
Contains news and industry
performance on a daily
basis.
www.smartmoney.com
Provides sector and market
performance—feature is
map of market.
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WEBSITE
www.wsj.com
COMMENTS
Provides limited info about
industry data; has searchable
archive on articles about
companies and industries –
Most content requires
subscription to access.
www.corporateinformation.com Provides links to info on
industries and by country –
Requires free registration.
www.ita.doc.gov
Provides access to industry
reports that are fee based.
www.investorguide.com
Has links to sites providing
sector and industry info.
44