Lecture 5 MBF2253 | Modern Security Analysis Prepared by Dr Khairul Anuar

1. Lecture 5MBF2253|Modern Security Analysis Prepared by Dr Khairul Anuar L5: Industry Analysis

2. Industry Analysis Questions to be answered: • Is there a difference between the returns for alternative industries during specific time periods? What is the implication of these results? • Is there consistency in the returns for individual industries over time? What do these results imply regarding industry analysis? • Is the performance for firms within an industry consistent? What is the implication of these results for industry and company analysis? • Is there a difference in risk among industries? What are the implications of these results for industry analysis? • Given the present value of cash flow valuation techniques, how does an analyst determine the value of an industry using the DDM and assuming constant growth or two stage growth?

3. Industry Analysis • How does an analyst determine the value of an industry using the free cash flow to equity (FCFE) model with constant growth or two stage growth? • What happens to risk for individual industries over time? What does this imply for industry analysis? • What are the steps involved in estimating earnings per share for an industry? • What are the stages in the industrial life cycle and how does the life cycle stage affect the sales estimate for an industry? • What are the five basic competitive forces that determine the intensity of competition in an industry and thus, its rate of return on capital?

4. Industry Analysis • How does the estimating procedure for the operating profit differ for the aggregate market versus an industry? • What are the two alternative procedures for estimating an industry earnings multiplier? • What is involved in a macroanalysis of the industry earnings multiplier? • What are the steps in the microanalysis of an industry earnings multiplier? • After you estimate an industry earnings multiplier, how do you determine if the industry’s multiplier is relatively high or low? • How do industries differ in terms of what dictates their return on assets? • What are some of the unique factors that must be considered in global industry analysis?

5. Why Do Industry Analysis? • Help find profitable investment opportunities that have favorable return-risk characteristics • Part of the three-step, top-down plan for valuing individual companies and selecting stocks for a portfolio • Can we spot trends in industries that make them good investments?

6. What Do We Learn From Industry Analysis? • Is there a difference between the returns for alternative industries during specific time periods? • Will an industry that performs well in one period continue to perform well in the future? That is, can we use past relationships between the market and an individual industry to predict future trends for the industry? • Do firms within an industry show consistent performance over time? • Is there a difference in the risk for alternative industries? • Does the risk for individual industries vary or does it remain relatively constant over time?

7. Cross-Sectional Industry Performance • To find out if the rates of return among different industries varied during a given period (eg year 2009), researchers compared the performance of alternative industries during a specific period. • Similar performance during specific periods for different industries would indicate that industry analysis is not necessary. • Eg if in 2009, the aggregate stock market experienced a rate return of 10% and the returns for all industries ranges between 9% and 10%. • Studies found that wide dispersion in rates of return in different industries. See exhibit 13.1 and Exhibit 13.2 • Performance varies from year to year

8. Industry Performance over Time • Studies: does industries that perform well in one time period would perform well in subsequent time periods, or outperform the aggregate market in the later time period. • Research shows that there is almost no association in individual industry performance year to year or over sequential rising or falling markets • Results imply that past performance alone does not project future industry performance • Variables that affect industry performance change over time

9. Performance of the Companies within an Industry • Studies: examined whether there is consistency in the performance of companies within an industry • There is wide dispersion in the performance of companies within an industry • This reinforces the need for company analysis in addition to industry analysis • Also IA is useful, it is easier to select a superior company from a good industry than to find good company in a poor industry. • By selecting the best stocks within a strong industry, we can avoid the risk that your analysis and selection of a good company is offset by poor industry performance.

10. Differences in Industry Risk • 1. Does risk differ among industries during given period? • 2. Are industry risk measures stable over time? • Empirical studies have found a wide range of risk among different industries at a point in time, and that differences in industry risk typically widened during rising and falling markets • Although risk measures for different industries have shown substantial dispersion during a period of time, individual industries’ risk measures are stable over time • Analysis of industry risk is necessary, this analysis is useful when estimating the future risk for an industry

11. Economic trends can and do affect industry performance By identifying and monitoring key assumptions and variables, we can monitor the economy and gauge the implications of new information on our economic outlook and industry analysis The Business Cycle and Industry Sectors

12. Economic trends can take 2 basic forms: Cyclical or Structural Changes Cyclical changes in the economy arise from the ups and downs of the business cycle Structure changes occur when the economy undergoes a major change in organization or how it functions. Eg. excess labor or capital may exist in some sectors whereas shortages of labor and capital exist elsewhere Rotation strategy is when one switches from one industry group to another over the course of a business cycle When trying to determine which industry groups will benefit from next stage of the business cycle, investors need to monitor economic trends and changes in industry characteristics. The Business Cycle and Industry Sectors