Investments: Analysis and Behavior

1. Investments: Analysis and Behavior Chapter 9 - Business Environment

2. Learning Objectives • Know the major forces driving economic growth • Define the economic environment • Identify industries /sectors • Learn the impact of regulation • Analyze the level of corporate governance in a firm

3. Current Events Article • Title: Consumer Sentiment Dips to Lowest Since November • Author: Caroline Valetkevitch • Source: Reuters • Link: http://www.reuters.com/article/idUSTRE69S2LA20101029?loomia_ow=t0:s0:a49:g43:r3:c0.200000:b38946892:z0

4. Fundamental Analysis • Top-down approach • Economy aspects • Industry aspects • Firm specific • Accounting - Recording, reporting and analysis of financial transactions of a business • Valuation: value (bargains) vs. growth (without regard for money) firms

5. Dimensions of the Economy • As the economy goes, so goes the businesses and their stock(s)… • Macroeconomic Environment • Aggregate Economic Activity • Gross Domestic Product ($14,730.2 Billion) • The total value of all goods and services produced by all people within the boundaries of a country during a one-year period • Interest rates (0.25 percent) • Consumer spending and consumer income • Employment (9.2% unemployment rate) • Microeconomic Environment • Industry, Firm, Plant, or Product Level • Industry specific regulation • Material prices

6. Forces Driving the Economy 1) Demographics • Baby boom generation • Born 1946 through 1964 • Significant impact on society: • spending • saving • working/retirement • housing

7. 2) Productivity • The ability to produce more products and services with the same number of people. • When productivity growth is robust, the standard of living increases. • Gains are often made from advances in technology • Computers, Internet, etc.

8. 3) International Trade • Imports • Exports • Balance of trade • The total value of a nation’s exports minus the total value of its imports over some period of time • Trade deficit • A negative (unfavorable) balance of trade—imports exceed exports in value • Balance of payments • The total flow of money into a country minus the total flow of money out of that country over a period of time

9. U.S. International Trade in Goods Source: U.S. Department of Commerce, International Trade Administration, U.S. Bureau of Economic Analysis, http://bea.gov/international/bp_web/simple.cfm?anon=78260&table_id=1&area_id=3, accessed September 18, 2008.

10. Value of U.S. Merchandise Exports and Imports Source: U.S. Department of Commerce, International Trade Administration, http://www.census.gov/foreign-trade/statistics/ highlights/top/top0712.html, accessed September 22, 2008.

11. Business Cycles • Pattern of economic recession and expansion • Periods of economic expansion are followed by periods of contractions • Recession is a sustained period of generally declining economic activity (GDP) • Higher unemployment • Restricted credit • Reduced output • Depression • Devastating recession

12. Economic Indicators • Inflation rate • An economic statistic that tracks the increase in prices of goods and services over a period of time; usually calculated on a monthly or annual basis • National income • The total income earned by various segments of the population, including employees, self-employed individuals, corporations, and other type of income • New housing starts • The total number of new homes started during a specific time period. • Unemployment rate • The percentage of a nation’s labor force unemployed at any time

13. Competitive Environment • Industry’s market structure • Number and size of competitors • Conditions of entry and exit • Monopoly • Oligopoly • Competitive advantage • Better • Cheaper • Faster http://www.forbes.com/lists/2009/18/global-09_The-Global-2000_Sales.html

14. Michael Porter’s Five Forces • Rivalry among existing competitors • Threat of new entrants • Pressure from substitute products • Bargaining power of customers • Bargaining power of suppliers

15. Legal Environment • Regulation • All sectors of the US economy are regulated to some degree. • OSHA, EPA, etc. • Some industries have high regulation • Banks, utilities, etc. • Costs of regulation are very high

16. Antitrust Policy • Monopoly • A market (or industry) with only one seller • Government promotes competition • Reviews mergers for impact on competition

17. Corporate Governance • Principal-agent problem • Separation of ownership and control • Stockholders own the firm with little control • Managers control the firm with little ownership • Why should the managers (agents) care about stockholders? • Corporate governance is the monitoring devices and incentives in place to protect stockholders.

18. Executive Compensation • Aligning managerial incentives • Salary • Fixed amount • Bonus • Additional pay for meeting various accounting targets • Incentive pay • Options, stock, restricted stock • Benefits and Perks http://money.cnn.com/2009/08/14/news/companies/highest_paid_ceos

19. Monitoring Executives • Board of Directors • Active shareholders • Institutional investors • Auditors • Analysts • Investment banks • Credit rating agencies • SEC

20. Ownership Structure • Corporate ownership • Stock • The shares of ownership of a corporation • Stockholder • A person who owns a corporation’s stock • Closed corporation • A corporation whose stock is owned by relatively few people and is not sold to the general public • Open corporation • A corporation whose stock is bought and sold on security exchanges and can be purchased by any individual • Inside equity • Shares held by top management. • Does high inside equity mean managers: • Are aligned with shareholders? • Are entrenched?

21. Hierarchy of Corporate Structure Stockholders exercise a great deal of influence through their right to elect the board of directors