Post on 21-Dec-2015
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Chapter 10Chapter 10
ECONOMIC AND INDUSTRY ANALYSIS
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Chapter 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?
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Chapter 10 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?
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Chapter 10 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?
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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.
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Generic Approaches to Security Analysis
Two basic approaches:Emphasize history, looking for trendsFocusing on the future
Still look at some historical information, but focus on looking forward to future trends
Top-down approachBottom-up approach
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Generic Approaches to Security Analysis
Top-Down Approach (Our focus)1. Review the macro-economy2. Analyze different industries and sectors3. Determine buy/sell candidates
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
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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 spendingInvestment spendingGovernment expendituresExport and import activity
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A Quick Review of Economic Concepts
Domestic Economic Activity Domestic Economic Policies
Monetary policyPolicies of the Fed to control the money supply and thereby affect
the overall economyOpen market operationsDiscount rate changesReserve requirement changes
Fiscal policyGovernment taxing and spending policies to influence the
economy and pursue other public interests
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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
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Economic and Security Market Influences
As we forecast economic growth, a number of factors will influence our expectations
Influences on Long-term ExpectationsTechnologyPopulationLabor force participationProductivityResource availabilityIncentives to expand
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Economic and Security Market Influences
Influences on Short-term ExpectationsInfluences caused by fluctuations in demandLiquidity and bank lendingMonetary policyInflationInterest ratesInternational influencesConsumer sentimentTax and other fiscal policyEconomic “shocks”
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Forecasting Tools
Searching for leading indicators that will provide signals of future economic directions
Inflation IndicatorsInflation at times is related to turning points in the business
cycleInflation destroys the purchasing power of wealthFederal Reserve actions indicate likely trends in inflation
Money supply and money growth rates relative to measures of economic growth
Commodity prices
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Forecasting Tools
Monetary IndicatorsImpact both inflation and liquidityFederal Reserve policy
Differences in Interest RatesThe Treasury yield curve can sometimes give indications
about future economic growth Cyclical Economic Indicators
Tracking “official” leading economic indicators Econometric Modeling
Models developed to forecast economic variables
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Risks in Economic Forecasting
Dominated by “group think”Always using consensus numbers ensures no better than
average forecastsForecasts must be different (often) and yet still correct
(usually) to create value Many analysts are short-sighted Lots of data can overwhelm us Try to support a position Over-reliance on expected “normal” changes without regard
to the possibility of “shocks”
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Expectational Analysis
Underlying concept: Forecasting should take into account:
The current environmentAssumptions behind estimatesA procedure for monitoring both changes in the
environment and violations of the assumptions being made
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Expectational Analysis
In the top-down approach:1. Analyze the current macro-economy and make
assumptions about future monetary and fiscal policies.Apply the analysis to sectors of the economy, identifying key assumptions made about the link between macroeconomic variables and sectors.
2. Apply to industries, linking macro and sector variables and monitoring values over time.
3. Apply to firms, noting Economy-Industry-Firm assumptions that affect recommendations.
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Industry Analysis
Many stock research firms organized analysts by industry groupingIndustry-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
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Links Between the Economy and Industries
Economic trends affect industry performance Economic trends:
Cyclical changes Ups and down of the business cycleDifferent industries experience unique results depending on the
point within the business cycleMay call for a “rotation” strategy
Structural changesChanges in government institutions, regulatory environment,
changes in technology, many moreNeed to anticipate structural changes and analyze the likely impact
on various industries
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The Stock Market and the Business Cycle
Financial Stocks Excel
trough
peakConsumer Durables
Excel
Capital Goods Excel
Basic Industries
Excel
Consumer Staples Excel
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Structural Influences
In addition to economic changes, various other trends also represent structural influences that will having varying effects across industriesSocial Influences
Demographics: baby boom and beyondLifestyles: changing definition of “traditional”Social values: environment, alcohol, tobacco
TechnologyPolitics and Regulation
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Competitive Structure of an Industry
Porter’s competitive forces are factors that determine a firm’s competitive environmentRivalry among existing competitors
Both price-based and non-price-based competitionThreat of new entrants
Are there barriers to entry?Threat of substitute productsBargaining power of buyers
Volume discounts, quality demandsBargaining power of suppliers
Can suppliers increase prices or reduce quality?
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Industry Life Cycle
Another tool: 5-stage industry life cycle model:1. Pioneering development
After marketing or technological breakthrough
2. Rapidly accelerating industry growthMarket develops, strong demand, new entrants
3. Mature industry growthGrowth starts to flatten
4. Stabilization and market maturityGrowth matches industry growth
5. Deceleration of growth and declineDeclining profits, some losses, exit from industry
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Sources of Industry Information
Standard & Poor’s Industry SurveyCovers over 50 major industries
Standard & Poor’s Analysts HandbookContains financial data
Value Line Industry SurveyDivides firms into industry groups
Individual InvestigationRead annual reports, industry publicationsCollect other relevant data from SEC filings, published
informationField interviews