Chapter 12
Macroeconomic
and Industry
Analysis
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
Framework of Analysis
• Fundamental Analysis
– Analysis of the determinants of firm value,
specifically attempting to forecast the
earnings and dividends of a firm.
– Top down approach:
Analyze economy
Analyze industry
Analyze firm
12-2
Framework of Analysis
• Approach to Fundamental Analysis
– Industry analysis
• Critical to understand the competitiveness of
the industry
– Company analysis
• Detailed strategic and financial analysis of the
firm
• Why use the top-down approach?
12-3
The Business Cycle
• Recurring patterns of recession and
recovery
– Peak
– Trough
• Industry relationship to business cycles
– Cyclical industries
• Industries with above average sensitivity to the
state of the economy
– Defensive
• Industries with below average sensitivity to the
state of the economy
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Industry Analysis
• Performance can vary widely across
industries
– It is difficult to find a good stock in a poor
industry
12-5
Figure 12.8 Industry Stock Price
Performance, 2008
12-6
Defining an Industry
• It can be difficult to define an industry
– North American Industry Classification
System (NAICS) attempts to define
industry groups with a four or five digit
code:
• The first two digits broadly define the industry
group: NAIC code 23 = construction
• The last two or three digits define the industry
more narrowly
12-7
Sensitivity to Business Cycle
• Factors affecting sensitivity of earnings to
business cycles
– Sensitivity of sales of the firm’s product to the
business cycles
– Fixed costs and leverage
• Fixed costs are costs that do not vary with the level
of production.
• Fixed costs contribute to higher profitability when
sales are high, but will result in lower profitability
when sales are lower.
12-8
Sensitivity to Business Cycle
– Operating leverage
• Proportion of fixed operating costs as a percent of
total costs
• Greater operating leverage results in greater
swings in profits over the business cycle
– Airlines, automobiles
– Financial leverage
• Proportion of fixed financing costs as a percent of
total costs
• Greater financial leverage results in greater swings
in profits over the business cycle
– Airlines, banks, investment banks
12-9
Figure 12.11 A Stylized
Depiction
of the Business Cycle
12-10
Sector Rotation
Selecting Industries in line with the stage
of the business cycle:
• Peak
natural resource firms
• Contraction defensive firms
equipment, transportation and
• Trough
• Expanding
construction firms
cyclical industries
12-11
Figure 12.12 Sector Rotation
Illustrated
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Industry Life Cycles
Stage
Start-up
Consolidation
Maturity
Relative Decline
Sales Growth
Rapid & Increasing
Stable
Slowing
Minimal or Negative
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Figure 12.13 The Industry Life
Cycle
12-14
Industry Structure and
Performance (Porter Model)
Determinants of Industry Competition and
Profitability
• Threat of Entry
– New entrants reduce profitability
– Barriers to entry preserve profitability
•
•
•
•
•
•
Large scale required to be profitable (autos)
Secure distribution channels
Brand loyalty, unique differentiated product
Proprietary production technology
Intellectual property protections
Learning curve effects
12-15
Industry Structure and
Performance (Porter Model)
Determinants of Industry Competition and
Profitability
• Rivalry between existing competitors
– Equal competitors reduce profitability
– Slow industry growth,
Pressure to
– High fixed costs,
cut prices
– Scale economies,
12-16
Industry Structure and
Performance (Porter Model)
Determinants of Industry Competition and Profitability
• Pressure from substitute products
– Substitutes limit profitability (propane, natural gas)
• Bargaining power of buyers
– A buyer that purchases a large percent of an
industry’s output can limit the selling industry’s
profitability (auto parts suppliers)
• Bargaining power of suppliers
– A supplier that controls a key input can limit the
buying industry’s profitability (labor unions)
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