Topic 3: Valuation of Equity ( (ii) Industry Analysis: Return expectation elements) Flashcards
Industry Analysis: Return Expectation Elements (list them)
Industry Analysis: Return Expectation Elements
- Demand Analysis
- Value Creation
- Industry life cycle stages
- Competition structure: The degree of industry concentration
- Competitive advantage
- Competitive strategies
- Sector rotation
Industry Analysis: Return Expectation Elements (Demand Analysis)
Demand Analysis:
• Usually surveys of demand as well as explanatory regressions are used to try to estimate demand.
- Analysts try to find a leading indicator that will provide some forecast of demand
- Analysts try to estimate the sensitivity of sales to global and national GDP changes.
- Example: What is the sensitivity of auto sales to global and national GDP changes or income changes?
Industry Analysis: Return Expectation Elements (Value Creation)
• Value Creation along the value chain.
• Value chain is the set of transformations in moving
from raw materials to product/service delivery.
- Value added at each transformation stage is partly a function of four major factors:
- The learning (experience) curve: As companies produce more output, they gain experience, so that the cost per unit produced declines
- Economies of scale (iPhone): As a company expands, its fixed costs may be spread over a larger output, and average costs decline over a range of output
- Economies of scope (iPod->iPhone->iPad->iMac … iCar, iHome): As a company produces related products, experience and reputation with one product may spill over to another product.
- Network externalities: Some products and services gain value as more consumers use them, so that they are able to share something popular.
Industry Analysis: Return Expectation Elements (Industry life cycle stages)
- Industry life cycle stages are usually categorised by rates of growth in sales.
- Growth stages:
- Pioneer stage:
- Rapid accelerating growth stage:
- Mature growth stage
- Stabilization of growth
- Deceleration of growth
Industry Analysis: Return Expectation Elements (Competition structure)
- Competition structure: The degree of industry concentration.
- 2 methods used:
- N firm concentration ratio:
• The combined market share of the largest N firms
in the industry.
• It provides an intuitive sense of industry
competition. - Herfindahl index:
• Has a value that is always smaller than one, if H<0.1 —> unconcentrated industry, 0.1 moderate concentration, H>0.18 —> high concentration
• A small index indicates a competitive industry with no dominant players.
Industry Analysis: Return Expectation Elements (Competitive advantage)
- Competitive advantage
- National factors that can lead to a competitive advantage include:
- Human capital, perhaps measured by years of schooling.
- Demand conditions such as the size and growth of the domestic market.
- Related supplier and support industries such as the computer software industry to support hardware industry.
- Corporate governance, management practices and financial climate.
Industry Analysis: Return Expectation Elements (Competitive strategies)
- Competitive strategies: Set of actions that a firm is taking to optimize its future competitive position.
- Porter distinguishes three competitive strategies:
- Cost leadership: the firm seeks to be the low-cost producer in its industry
- Differentiation: their seeks to provide product benefits that other firms do not provide
- Focus: the firm targets a niche with either a cost or a benefit (differentiation) focus
Industry Analysis: Return Expectation Elements (Sector rotation)
- Sector rotation: A popular investment timing strategy.
- Consumer cyclical industries (durables and non durables) correlate highly with the economy as a whole, these industries do well in the early and middle growth portion of the business cycle.
- Defensive consumer staples maintain their profitability during recessions.
- A successful sector rotation strategy requires extensive industry analysis.
Analysis should examine risk elements evidenced by:
Analysis should examine risk elements evidenced by:
- Market competition
- Value chain competition
- Rivalry Intensity
- Substitutes
- Buyer and supplier power
- New entrants
- Government participation
- Cash flow covariance
Industry Analysis: Return Expectation Elements (Industry life cycle stages: Pioneering Development)
Pioneering Development is the 1st stage, and has a low but slowly increasing industry sales growth rate.
Substantial development costs and acceptance by only early adopters can lead to low profit margins
Industry Analysis: Return Expectation Elements (Industry life cycle stages: Rapid accelerating growth stage)
Rapid accelerating growth stage is the 2nd stage and industry sales growth rate is still modest but rapidly increasing.
High profit margins are possible because firms from outside the new industry may face barriers to entering the newly established markets.
Industry Analysis: Return Expectation Elements (Industry life cycle stages:Mature growth stage)
Mature growth stage is the 3rd stage, and has high but more modestly increasing industry sales growth rate.
The entry of competitors lowers profit margins, but the return on equity is high
Industry Analysis: Return Expectation Elements (Industry life cycle stages: Stabilization of growth)
Stabilization of growth is the 4th stage and has a high but only slowly increasing sales growth rate.
The sales growth rate has not yet begun to decline, but increasing capacity and competition may cause returns on equity to decline to the level of average returns on equity in the economy
Industry Analysis: Return Expectation Elements (Industry life cycle stages: Deceleration of growth)
Deceleration of growth is the 5th stage, with a decreasing sales growth rate.
At this stage, the industry may experience overcapacity, and profit margins may be completely eroded.
