Transcript Investments: Analysis and Behavior

Investments: Analysis
and Behavior
Chapter 9- Business
Environment
©2008 McGraw-Hill/Irwin
Learning Objectives
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
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Know the major forces driving economic growth.
Define the economic environment.
Identify industries and sectors.
Learn the impact of regulation.
Analyze the level of corporate governance in a firm.
9-2
Dimensions of the Economy


As the economy goes, so goes the businesses
and their stock…
Macroeconomic Environment
 aggregate
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


economic activity
Gross Domestic Product
Interest rates
Consumer spending, consumer income
employment
Microeconomic Environment
 industry,


firm, plant, or product level
Industry specific regulation
Material prices (aluminum, wheat, oil, etc.)
9-3
Forces Driving the Economy
1) Demographics
 Baby

boom generation
Born 1946 through 1964
Significant impact on
society:
Figure 9.1 U.S. 2005 Population Distribution
• spending
25,000
Population in Age Group (in thousands)
Baby Boom Generation
• saving
20,000
• working/retirement
• housing
15,000
10,000
5,000
0
<5
5 to 9 10 to 15 to 20 to 25 to 30 to 35 to 40 to 45 to 50 to 55 to 60 to 65 to 70 to 75 to 80 to > 84
14
19
24
29
34
39
44
49
54
59
64
69
74
79
84
Age (in years)
9-4
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.
Figure 9.3 Actual and Trend in Labor Productivity
150
Index, 1992 = 100
Trend = 2.5% per year
130
110
Trend = 1.28% per year
90
Actual
70
Trend = 2.51% per year
Source: US Bureau of Labor Statistics
2005
2000
1995
1990
1985
1980
1975
1970
1965
50
1960
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9-5
Quarterly Trade Deficits
-200
Jan-05
Quarter Trade Surplus/Deficit
3) International Trade
Imports
Exports
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
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Jan-96
Jan-95
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Jan-91
Jan-90
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Jan-75
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Jan-72
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Jan-70
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Jan-64
Jan-63
Jan-62
Jan-61
Jan-60
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4
3
2
1
0
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0
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9-6
Business Cycles
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Pattern of economic recession and
expansion
 Periods
of economic expansion are
followed by periods of contractions

Recession
2 or more concessive quarters of contraction
 Higher unemployment
 Restricted credit
 Reduced output
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Depression

Severe recession (no official definition)
9-7
9-8
Economic Indicators
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Data series that successfully
describe the pattern of projected,
current, or past economic activity.

Leading indicators
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Lagging Indicators
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Money Supply, building permits,
manufacturer’s new orders, initial claims
for unemployment
Consumer price index, inventories,
labor cost
Coincident Indicators
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Industrial production, personal income,
payrolls
9-9
Sentiment Surveys
What people say about their economic plans:
9-10
Grouping and Classifying the Economy and Companies
Code
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Industry Classifications
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Categorize companies by
the principal activity in
which they are engaged.
North American Industry
Classification System
(NAICS)
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US Census Bureau
Two to six digits
Industry
11
Agriculture, Forestry, Fishing, and Hunting
21
Mining
22
Utilities
23
Construction
31
Manufacturing
42
Wholesale Trade
44-45
Retail Trade
48-49
Transportation and Warehousing
51
Information
52
Finance and Insurance
53
Real Estate and Rental and Leasing
54
Professional, Scientific and Technical Services
55
Management of Companies and Enterprises
56
Admin. and Support, Waste Mgmt, and Remediation
61
Educational Services
62
Health Care and Social Assistance
71
Arts, Entertainment and Recreation
72
Accommodation and Food Services
81
Other Services (except Public Administration)
92
Public Administration
9-11
Standard & Poor’s Sectors
9-12
Competitive Environment

Industry’s market structure
 Number
and size of competitors
 Monopoly
 Oligopoly

Competitive advantage
9-13
Michael Porter characterizes the competitive
environment -- five forces
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Rivalry among existing competitors
Threat of new entrants
Pressure from substitute products
Bargaining power of customers
Bargaining power of suppliers
9-14
Measuring Competitiveness

Concentration ratios
 Measures
the percentage market share concentrated
in an industry’s top four, eight, twenty, or more firms.
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
0 to 100
Low numbers indicate vigorous competition: greater than
80% means highly concentrated
n
CR n 
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 Firm Sales
i 1
i
Industry Sales
 100
Herfindahl Hirschmann Index (HHI)
 A measure

of competitor size inequality
0 to 10,000
n
HHI   % Industry Market Share i 
i 1
2
9-15
Consider an industry with $1 million in sales. The largest firm in the
industry has sales of $400,000, the second largest firm has sales of
$300,000, the third largest firm has sales of $200,000, and the
smallest firm has sales of $100,000. Calculate the CR1, CR2, and
CR4 for this industry. Is this industry competitive?
Solution:
From the formula for the CRn:
CR1 
400,000
 100  40.0
1,000,000
400,000  300,000
CR2 
 100  70.0
1,000,000
400,000  300,000  200,000  100,000
CR4 
 100  100.0
1,000,000
9-16
Consider an industry with $1 million in sales. The largest firm in the
industry has sales of $400,000, the second largest firm has sales of
$300,000, the third largest firm has sales of $200,000, and the smallest
firm has sales of $100,000. Calculate the HHI for this industry. Is this
industry competitive?
Solution:
From the formula for the HHI:
HHI = ∑ [(Firm Salesi/Industry Sales)  100]2
= [($400,000/$1,000,000)  100]2 + [($300,000/$1,000,000)  100]2 +
[($200,000/$1,000,000)  100]2 +
[($100,000/$1,000,000)  100]2
= 402 + 302 + 202 + 102
= 3,000
The HHI of 3,000 indicates that firms within this industry are operating in a
low competition environment and may have significant market power. 9-17
Legal Environment

Regulation
 All
sectors of the US economy are regulated
to some degree.
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OSHA, EPA, etc.
 Some
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industries have high regulation
Banks, utilities, etc.
 Costs
of regulation are very high
9-18
Antitrust Policy
Government promotes competition
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Reviews mergers for impact on competition
Bureau of Competition, Federal Trade Commission
Antitrust Division, Department of Justice
Figure 9.5 Mergers and Antitrust Activity
Merger Announced
4,926
FTC or DOF Investigated
Number of Cases

4,728
4,642
3,702
3,087
2,816
2,376
2,305
1,454
1,187
73
1994
101
1995
99
1996
122
1997
125
1998
113
1999
1,014
98
70
49
35
89
2000
2001
2002
2003
2004
Source: 2005 Annual Report to Congress, Federal Trade Commission and Department of Justice
9-19
Corporate Governance
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Principle-agent problem

Separation of ownership and
control
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Stockholders own the firm with
little control
Managers control the firm with
little ownership
Why should the managers care
about the stockholders?
Corporate governance is the
monitoring devices and
incentives in place to protect
stockholders.
9-20
Executive Compensation
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Aligning managerial incentives
 Salary
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Fixed amount
 Bonus
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Additional pay for meeting various accounting targets
 Incentive
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pay
Options, stock, restricted stock
 Benefits
and Perks
9-21
9-22
Monitoring Executives
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Board of Directors
Active shareholders
 Institutional
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investors
Auditors
Analysts
Investment banks
Credit rating agencies
SEC
9-23
Sarbanes-Oxley Act
July of 2002
 New oversight body to regulate auditors
 Created laws pertaining to corporate
responsibility
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 Boards
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Independence, structure
 Managers
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Responsibility for financial reports
Increased punishments for corporate
white-collar crime
9-24
Ownership Structure
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Inside equity
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Shares held by top
management.
Does high inside equity
mean managers:
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Are aligned with
shareholders?
Are entrenched?
9-25