Chapter 12 - macroeconomic and industry analysis Flashcards
fundamental analysis
The analysis of determinants of firm value, such as prospects for earnings and dividends
exchange rate
The rate at which domestic currency can be converted into foreign currency
Gross domestic product (GDP)
- The market value of goods and services produced over a period of time
- Total production of goods and services
unemployment rate
The ratio of the number of people classified as unemployed to the total labor force
capacity utilization rate
the ratio of actual output from factories to potential output
inflation
The rate at which the general level of prices for goods and services is rising
what is the relationship between interest rates and valuations?
High interest rates reduce the PV of FCF
budget deficit
The amount by which government spending exceeds government revenues
what can government borrowing do to interest rates?
Large government borrowing can force up interest rates by increasing the total demand for credit in the economy
sentiment
Optimism or pessimism concerning the economy
Fundamental factors that determine the level of interest rates:
- supply of funds from savers, primarily households
- demand for funds from businesses to finance physical investments in plant, equipment, and inventories
- government’s net supply/demand for funds as modified by actions of the federal reserve bank
- expected rate of inflation
what is the relationship between the real interest rate and the supply of household savings?
- The higher the real interest rate, the greater supply of household savings
- Therefore, the supply curve slopes up
what is the relationship between the real interest rate and business investment?
- The lower the real interest rate, the more businesses will want to invest in physical capital
- Therefore, the demand curve slopes dow
demand shock
- An event that affects the demand for goods and services in the economy
- Usually characterized by aggregate output moving in the same direction as interest rates and inflation
examples of demand shocks
Reductions in tax rates, increases in money supply, government spending, or foreign export demand
supply shock
An event that influences production capacity and costs in the economy
Usually characterized by aggregate output moving in the opposite direction of inflation and interest rates
examples of supply shocks
Changes in energy prices; freezes, floods, or droughts that might destroy crops; changes in education level; or changes in the wage rate at which the labor force is willing to work
business cycles
- Recurring cycles of recession and recovery
- characterized by a peak and a trough
peak
The transition from the end of an expansion to the start of a contraction
trough
The transition point between recession and recovery
cyclical industries
Industries with above-average sensitivity to the state of the economy
examples of cyclical industries
Producers of durable goods (automobiles/large household appliances) and capital goods (goods used by other firms to produce their own products)
defensive industries
Industries with below-average sensitivity to the state of the econony
examples of defensive industries
Food producers/processors, pharmaceutical firms, and public utilities
leading indicators
Economic series that tend to rise or fall in advance of the rest of the economy
examples of leading indicators
Average weekly hours of production workers, initial claims for unemployment insurance, manufactures’s new orders, ISM Index of New Orders, new orders for nondefense capital goods, new private housing units authorized by local buildin gpermits, Yield curve: 10-year T-bond and federal funds rate spread, stock prices, leading credit index, index of consumer expectations for business conditions
coincident indicators
move in tandem with the economy
examples of coincident indicators
Employees on nonagricultural payrolls, personal income less transfer payments, industrial production, manufacturing and trade sales
lagging indicators
tend to rise or fall somewhat after the economy
examples of lagging indicators
Average duration of unemployment, ratio of manufacturing and trade inventories to sales, change in index of labor cost per unit of output, average prime rate charged by banks, commercial/industrial loans outstanding, ratio of consumer installment credit outstanding to personal income, change in CPI for services
NAICS codes
Classification of firms into industry groups using numerical codes to identify industries
breakdown of NAICS codes
- 1st 2 digits denote very broad industry classifications
- The next digits define the industry grouping more narrowly
- 1st 5 digits are common across all USMCA countries
- 6th digit is country-specific
- Forms with the same 4-digit codes are commonly taken to be in the same industry
3 factors that determine the sensitivity of a firm’s earning to the business cycle
- Sensitivity of sales
- Operating leverage (the division between fixed and variable costs)
- Firms with greater amounts of variable costs will
be less sensitive - Financial leverage (the use of borrowing)
- Interest payments on debt must be paid
regardless of sales
sector rotation
An investment strategy that entails shifting the portfolio into industry sectors that are expected to outperform others based on macroeconomic forecasts
sector rotation near the peak
invest in firms engaged in natural resource extraction and processing (minerals or petroleum)
sector rotation following a peak (contraction/recession)
invest in defensive industries
sector rotation at the height of the contraction
financial firms will be hurt by shrinking loan volume and higher default rates
sector rotation toward the end of the recession
contraction induce lower inflation and interest rates, which favor financial firms
sector rotation at the trough
the economy is poised for recovery/expansion, invest in cyclical industries, and firms might be purchasing new equipment, invest in capital goods industrious (equipment, transportation, or construction)
full sector rotation from trough to peak
technology→ consumer discretionary→ materials→ industrials→ energy
full sector rotation from peak to trough
health care→ consumer staples→ utilities→ financials
industry life cycle
- Start-up: extremely rapid growth
- Consolidation: growth that is less rapid but still faster than the general economy
- Maturity: growth no faster than the general economy
- Relative decline: growth that is less rapid than the general economy or shrinks
start-up
- extremely rapid growth
- New tech/product
- Difficult to predict which firms will be industry leaders
consolidation
- growth is less rapid but still faster than the general economy
- Product becomes established
- Industry leaders begin to emerge
- Market share is easier to predict
maturity
- growth no faster than the general economy
- Product has become far more standardized
- Narrower profit margins and further pressure on profits
- Relatively stable CF but little opportunity for expansion
relative decline
- growth that is less rapid than the general economy or shrinks
- Potential for obsolescence of the product, competition from new products or new low-cost suppliers
Lynch’s industry classification system
- Slow growers
- Stalwarts
- Fast growers
- Cyclicals
- Turnarounds
- Asset plays
slow growers
large/aging companies that will grow only slightly faster than the general economy
stalwarts
large, well known firms (Coca-Cola), grow faster than the slow growers, tend to be noncyclical
fast growers
small/aggressive new firms with annual growth rates of 20%-25%
cyclicals
sales/profits that regularly expand/contract with the business cycle
turnarounds
in bankruptcy or soon might be, if they recover, can offer tremendous investment returns
asset plays
have valuable assets not currently reflected in the price
five determinants of competition
- Threat of new entry
- Rivalry between existing competitors
- Pressure from substitute products
- Bargaining power of buyers
- Bargaining power of suppliers
threat of new entry
- New entrants put pressure on price and profits
- Barriers to entry can be a key determinant of industry profitability
- Secured distribution channels, brand loyalty, proprietary knowledge or patent protection, existing experience
rivalry between existing competitors
With several competitors, there will generally be more price competition and lower margins as competitors seek to expand their market share
pressure from substitute products
The industry faces competition from firms in related industries
bargaining power of buyers
If a buyer purchases a large fraction of an industry’s output, it will have bargaining power and can demand price concessions
bargaining power of suppliers
If a supplier of a key input has monopolistic control over the product, it can demand higher prices for the good and squeeze profits out of the industry
