26. Industry and Company Analysis

Question 1

Top-Down Revenue Projection

Answer 1

Begins at the level of the overall economy. Forecasts can then be made at more narrowly defined levels, such as sector, industry, and market for a specific product, to arrive at a revenue projection for the individual company.

Ex.
Growth Relative to GDP Growth

Market Growth and Market Share (top-down)

Question 2

Bottom-Up Revenue Projection

Answer 2

Begins at the level of the individual company or a unit within the company, such as individual product lines, locations, or business segments. Analysts then aggregate their projections for the individual products or segments to arrive at a forecast of total revenue for the company. Moreover, analysts also aggregate their revenue projections for individual companies to develop forecasts for a product market, industry, or the overall economy.

Ex.
Time-Series Forecasts
Return on Capital Forecasts
Capacity-based Measure Forecasts

Question 3

Hybrid Revenue Projection

Answer 3

Combines elements of both top-down and bottom-up analysis and can be useful for uncovering implicit assumptions or errors that may arise from using a single approach.

Most commonly used in practice.

For example, the analyst may use a market growth and market share approach to model individual product lines or business segments, and then aggregate the individual projections to arrive at a forecast for the overall company because the sum of forecast segment revenue equals the segment market size multiplied by the market share for all segments.

Question 4

Growth Relative to GDP Growth (top-down)

Answer 4

First forecast the growth rate of nominal gross domestic product, then consider how the growth rate of the specific company being examined will compare with nominal GDP growth.

Question 5

Market Growth and Market Share (top-down)

Answer 5

First forecast growth in a particular market, then considers the company’s current market share, and how that share is likely to change over time.

Question 6

Time-Series Forecasts

Answer 6

Forecasts based on historical growth rates or time-series analysis.

Question 7

Return on Capital Forecasts

Answer 7

Forecasts based on balance sheet accounts, for example interest revenue for a bank may be calculated as loans multiplied by the average interest rate.

Question 8

Capacity-based Measure Forecasts

Answer 8

Forecasts (for example, in retailing) based on same-store sales growth and sales related to new stores.

Question 9

Maintenance Capital Expenditures

Answer 9

Necessary to sustain the current business.

Question 10

Growth Capital Expenditures

Answer 10

Needed to expand the business.

Question 11

ROIC

Answer 11

ROIC measures the profitability of the capital invested by the company’s shareholders and debt holders.

ROIC is a better measure of profitability than return on equity because it is not affected by a company’s degree of financial leverage.

In general, sustainably high ROIC is a sign of a competitive advantage.

Question 12

ROCE

Answer 12

Essentially ROIC before tax.

Question 13

Sensitivity Analysis

Answer 13

Analysis that shows the range of possible outcomes as specific assumptions are changed; involves changing one assumption at a time.

Question 14

Scenario Analysis

Answer 14

Analysis that involves changing multiple assumptions at the same time.

Question 15

Porter’s 5 Forces

Answer 15

Threat of substitute products

Intensity of rivalry among incumbent companies

Bargaining power of suppliers

Bargaining power of customers

Threat of new entrants

Question 16

Threat of substitute products

Answer 16

If numerous substitutes exist and switching costs are low, companies have limited pricing power. Conversely if few substitutes exist and/ or switching costs are high, companies have greater pricing power.

Question 17

Intensity of rivalry among incumbent companies

Answer 17

The second force is the intensity of rivalry among incumbent companies. Pricing power is limited in industries that are fragmented, have limited growth, high exit barriers, high fixed costs, and have more or less identical product offerings.

Question 18

Bargaining power of suppliers

Answer 18

The third force is the bargaining power of suppliers. Companies (and overall industries) whose suppliers have greater ability to increase prices and/ or limit the quality and quantity of inputs face downward pressure on profitability. Suppliers’ bargaining power is generally a function of relative size, the relative importance the supplier places on a particular product, and the availability of alternatives.

Question 19

Bargaining power of customers

Answer 19

The fourth force is the bargaining power of customers. Companies (and overall industries) whose customers have greater ability to demand lower prices and/ or control the quality and quantity of end products face downward pressure on profitability. Buyer power is the reverse of supplier power. Bargaining power of customers is generally lower in markets with a fragmented customer base, a non-standardized product, and high switching costs for the customer.

Question 20

Threat of new entrants

Answer 20

The fifth force is the threat of new entrants. Companies in industries in which the threat of new entrants is high because of the presence of above-market returns face downward pressure on profitability. In contrast, if there are barriers to entry, it may be costly for new competitors to enter a market. It is easier for incumbents to raise prices and defend their market position when barriers to entry are high.

Question 21

Normalized Earnings

Answer 21

The expected level of mid-cycle earnings for a company in the absence of any unusual or temporary factors that affect profitability (either positively or negatively).