(40) Introduction to Industry and Company Analysis Flashcards Preview

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Flashcards in (40) Introduction to Industry and Company Analysis Deck (32)
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1
Q

LOS 49. a: Explain uses of industry analysis and the relation of industry analysis to company analysis. What is industry analysis necessary for?

A

Industry analysis is necessary for understanding a company’s business environment before engaging in analysis of the company.

2
Q

LOS 49. a: Explain uses of industry analysis and the relation of industry analysis to company analysis. What information can the industry environment provide?

A

The industry environment can provide information about the firm’s:

  • potential growth
  • competition, risks
  • appropriate debt levels, and;
  • credit risk.
3
Q

LOS 49. a: Explain uses of industry analysis and the relation of industry analysis to company analysis. What can industry valuation be used for?

A

Industry valuation can be used in an active management strategy to determine which industries to overweight or underweight in a portfolio.

4
Q

LOS 49. a: Explain uses of industry analysis and the relation of industry analysis to company analysis. What is industry representation often a component in?

A

Industry representation is often a component in a performance attribution analysis of a portfolio’s return.

5
Q

LOS 49. b: Compare methods by which companies can be grouped, current industry classification systems, and classify a company, given a description of its activities and the classification system.

A

Firms can be grouped into industries according to their products and services or business cycle sensitivity, or through statistical methods that group firms with high historical correlation in returns.

6
Q

LOS 49. b: Compare methods by which companies can be grouped, current industry classification systems, and classify a company, given a description of its activities and the classification system. What are the industry classification systems from commercial providers?

A

Industry classification systems from commercial providers include:

  • the Global Industry Classification Standard (Standard & Poor’s and MSCI Barra),
  • Russell Global Sectors, and;
  • Industry Classification Benchmark (Dow Jones and FTSE).
7
Q

LOS 49. b: Compare methods by which companies can be grouped, current industry classification systems, and classify a company, given a description of its activities and the classification system. What are the industry classification systems from government agencies?

A

Industry classification systems developed by government agencies include:

  • the International Standard Industrial Classification (ISIC)
  • the North American Industry Classification System (NAICS), and;
  • systems designed for the European Union and Australia/New Zealand.
8
Q

LOS 49. c: Explain the factors that affect the sensitivity of a company to the business cycle and the uses and limitations of industry and company descriptors such as “growth,” “defensive,” and “cyclical”.

A

A cyclical firm has earnings that are highly dependent on the business cycle.

A non-cyclical firm has earnings that are less dependent on the business cycle.

Industries can also be classified as cyclical or non-cyclical.

Non-cyclical industries or firms can be classified as defensive (demand for the product tends not to fluctuate with the business cycle) or growth (demand is so strong that it is largely unaffected by the business cycle).

9
Q

LOS 49. c: Explain the factors that affect the sensitivity of a company to the business cycle and the uses and limitations of industry and company descriptors such as “growth,” “defensive,” and “cyclical”.

A

Limitations of descriptors such as growth, defensive, and cyclical include the facts that cyclical industries often include growth firms;

even non-cyclical industries can be affected by severe recessions;

defensive industries are not always safe investments;

business cycle timing differs across countries and regions; and

the classification of firms is somewhat arbitrary.

10
Q

LOS 49. d: Explain how a company’s industry classification can be used to identify a potential “peer group” for equity valuation.

A

A peer group should consist of companies with similar:

  • business activities
  • demand drivers
  • cost structure drivers, and;
  • availability of capital

To form a peer group, the analyst will often start by identifying companies in the same industry, but the analyst should use other information to verify that the firms in an industry are comparable.

11
Q

LOS 49. e: Describe the elements that need to be covered in a thorough industry analysis.

A

A thorough industry analysis should:

  • Evaluate the relationships between macroeconomic variables and industrial trends.
  • Estimate industry variables using different approaches and scenarios.
  • Check estimates against those from other analysts.
  • Compare the valuation for different industries.
  • Compare the valuation for industries across time an determine risk and rotation strategies.
  • Analyze industry prospects based on strategic groups.
  • Classify industries by their life-cycle stage.
  • Position the industry on the experience curve.
  • Consider demographic, macroeconomic, governmental, social, and technological influences.
  • Examine the forces that determine industry competition.
12
Q

LOS 49. f: Describe the principles of strategic analysis of an industry.

A

Strategic analysis of an industry involves analyzing the competitive forces that determine the possibility of economic profits.

Porter’s five forces that determine industry competition are:

  • Revelry among existing competitors
  • Threat of entry
  • Threat of substitutes
  • Power of buyers
  • Power of suppliers
13
Q

LOS 49. g: Explain the effects of barriers to entry, industry concentration, industry capacity, and market share stability on pricing power and price competition.

A

High barriers to entry prevent new competitors form taking away market share, but they do not guarantee pricing power or high return on capital, especially if the products are undifferentiated or barriers to exit result in overcapacity. Barriers to entry may change over time.

14
Q

LOS 49. g: Explain the effects of barriers to entry, industry concentration, industry capacity, and market share stability on pricing power and price competition.

A

While market fragmentation usually results in strong competition and low return on capital, high industry concentration may not guarantee pricing power. If industry products are undifferentiated, consumers will switch to the cheapest producer. Overcapacity may result in price wars.

15
Q

LOS 49. g: Explain the effects of barriers to entry, industry concentration, industry capacity, and market share stability on pricing power and price competition.

A

Capacity is fixed in the short run and variable in the long run. Undercapacity typically results in pricing power. Producers may overinvest in new capacity, especially in cyclical industries or in the capacity is physical and specialized. Non-physical capacity comes into production and can be reallocated more quickly than physical capital.

16
Q

LOS 49. g: Explain the effects of barriers to entry, industry concentration, industry capacity, and market share stability on pricing power and price competition.

A

Highly variable market shares indicate a highly competitive industry. Stable market shares suggest less intense competition. High switching costs contribute to market share stability.

17
Q

LOS 49. h: Describe industry life cycle models, classify an industry as to life cycle stage, and describe limitations of the life-cycle concept in forecasting industry performance. The industry experience curve shows the cost per unit relative to what?

A

The experience curve shows the cost per unit relative to output. Unit cost declines at higher output volume because of increases in productivity and economies of scale, especially in industries with high fixed costs.

18
Q

LOS 49. h: Describe industry life cycle models, classify an industry as to life cycle stage, and describe limitations of the life-cycle concept in forecasting industry performance. List them.

A

Phases of the industry life-cycle model are the embryonic, growth, shakeout, maturity, and decline stages.

19
Q

LOS 49. h: Describe industry life cycle models, classify an industry as to life cycle stage, and describe limitations of the life-cycle concept in forecasting industry performance. Define the embryonic stage.

A

Embryonic stage: Slow growth; high prices; large investment required; high risk of failure

20
Q

LOS 49. h: Describe industry life cycle models, classify an industry as to life cycle stage, and describe limitations of the life-cycle concept in forecasting industry performance. Define the growth stage.

A

Growth stage: Rapid growth, little competition, failing prices, increasing profitability

21
Q

LOS 49. h: Describe industry life cycle models, classify an industry as to life cycle stage, and describe limitations of the life-cycle concept in forecasting industry performance. Define the shakeout stage.

A

Shakeout stage: Slowing growth, intense competition, industry overcapacity, declining profitability, cost cutting, increased failures

22
Q

LOS 49. h: Describe industry life cycle models, classify an industry as to life cycle stage, and describe limitations of the life-cycle concept in forecasting industry performance. Define the mature stage.

A

Mature stage: Slow growth, consolidation, high barriers to entry, stable pricing, superior firms gain market share

23
Q

LOS 49. h: Describe industry life cycle models, classify an industry as to life cycle stage, and describe limitations of the life-cycle concept in forecasting industry performance. Define the decline stage.

A

Decline stage: Negative growth, declining prices, consolidation

24
Q

LOS 49. h: Describe industry life cycle models, classify an industry as to life cycle stage, and describe limitations of the life-cycle concept in forecasting industry performance.

A

A limitation of life-cycle analysis is that life-cycle stages may not be as long or short as anticipated or might be skipped altogether due to technological change, government regulation, societal change, or demographics. Firms in the same life-cycle stage will experience dissimilar growth and profits due to their competitive positions.

25
Q

LOS 49. i: Compare characteristics of representative industries from the various economic sectors.

A

The elements of an industry strategic analysis are:

  • the major firms
  • barriers to entry
  • industry concentration
  • influence of industry capacity on pricing
  • industry stability
  • life cycle
  • competition
  • demographic influences
  • government influences
  • social influence
  • technological influence, and;
  • whether the industry is growth, defensive, or cyclical.
26
Q

LOS 49. j: Describe macroeconomic, technological, demographic, governmental, and social influences on industry growth, profitability, and risk.

A

Macroeconomic influences on industries include long-term trends in factors such as GDP growth, interest rates, and inflation, as well as structural factors such as the education level of the workforce.

27
Q

LOS 49. j: Describe macroeconomic, technological, demographic, governmental, and social influences on industry growth, profitability, and risk.

A

Demographic influences include the size and age distribution of the population.

28
Q

LOS 49. j: Describe macroeconomic, technological, demographic, governmental, and social influences on industry growth, profitability, and risk.

A

Government factors include tax rates, regulations, empowerment of self-regulatory organizations, and government purchases of goods and services.

29
Q

LOS 49. j: Describe macroeconomic, technological, demographic, governmental, and social influences on industry growth, profitability, and risk.

A

Social influences relate to how people interact and conduct their lives.

30
Q

LOS 49. j: Describe macroeconomic, technological, demographic, governmental, and social influences on industry growth, profitability, and risk.

A

Technology can dramatically change an industry through the introduction of new or improved products.

31
Q

LOS 49. k: Describe the elements that should be covered in a thorough company analysis.

A

Company analysis should include an overview of:

  • the firm
  • industry characteristics, and;
  • analysis of product demand, product costs, and pricing environment, the firm’s financial ratios, and projected financial statements and firm valuation.
  • The analysis should describe the company’s competitive strategy.
32
Q

LOS 49. k: Describe the elements that should be covered in a thorough company analysis. What are the two strategies a company can employ?

A

Companies can employ a cost leadership (low-cost) strategy or a product or service differentiation strategy. A cost leadership firm seeks to have the lowest cost of production in its industry, offer the lowest prices, and generate enough volume to make a superior return. A differentiating firm’s products and services should be distinctive in terms of type, quality, or delivery.

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