Transcript Industry Structure and Performance (Porter Model)

Chapter 12
Macroeconomic
and Industry
Analysis
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
12.1 The Global Economy
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Framework of Analysis
• Fundamental Analysis
– Analysis of the determinants of firm value,
specifically attempting to forecast the
earnings and dividends of a firm.
– Top down approach:
Analyze economy
Analyze industry
Analyze firm
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Framework of Analysis
• Approach to Fundamental Analysis
– Domestic and global economic analysis
• Performance in countries and regions is highly
variable
• Politics affects the economy
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Framework of Analysis
• Approach to Fundamental Analysis
– Foreign exchange rates affect U.S. firms
and their competitors
• How are the following affected by a change in
the value of the dollar?
– Ski resort in Aspen Colorado
– Profits of Rocky Mountain Log homes, an exporter of
log homes around the world
– Yen profit on sale of Toyota cars in U.S.
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Exchange Rate Risk
• Exchange rate risk can affect:
– Sales
– Profits
– Stock returns
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Framework of Analysis
• Approach to Fundamental Analysis
– Industry analysis
• Critical to understand the competitiveness of
the industry
– Company analysis
• Detailed strategic and financial analysis of the
firm
• Why use the top-down approach?
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Table 12.1 Economic Performance,
2008
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Figure 12.1 Change in Real Exchange
Rate: Dollar Versus Major Currencies.
1999-2008
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12.2 The Domestic
Macroeconomy
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Key Economic Variables
• Gross domestic product
– The market value of gods and services
produced domestically in a given time period
• Unemployment rate
– The ratio of number of people classified as
unemployed to the total labor force
• Inflation
– The rate of change in the general price level
as measured by some price index:
• Consumer Price Index
• Producer Price Index
• GDP Deflator
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Key Economic Variables
• Interest rates
– Major impact on security prices (stocks and
bonds) and the level of economic growth
• Budget Deficits
– The budget deficit is the amount by which
government spending exceeds government
revenues
– Budget deficits can crowd out private
investment, private investment generates
more growth than public sector investment.
– Alternative to crowding out is overreliance on
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foreign borrowing.
Key Economic Variables
• Consumer sentiment
– Consumers’ optimism or pessimism
concerning the economy and job prospects.
Source: Federal Reserve Bank of St. Louis, National
Economic Trends, May 2009
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Figure 12.2 S&P 500
Versus EPS Estimate
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12.3 Interest Rates
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Factors Determining the Level of
Interest Rates
1. Supply of funds from savers
2. Demand for funds from businesses
3. Government’s net supply and/or demand for
funds
– Fiscal policy
– Monetary policy
4. Expected rate of inflation
– Interest rates contain a premium for expected
inflation
– The Federal Reserve typically raises interest
rates proactively when inflation is expected
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to increase
Figure 12.3 Determination of the
Equilibrium Real Rate of Interest
How would an increase in the government budget
deficit affect the equilibrium interest rate?
If the Federal Reserve wishes to stimulate
growth how would they choose to affect the
money supply? Would it work?
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12.4 Demand and Supply
Shocks
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Demand Shocks
• Demand Shock
– An event that affects the demand for
goods and services, some examples
include:
•
•
•
•
Change in tax rates
Change in the money supply
Change in government spending
Change in foreign export demand
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Supply Shocks
• Supply Shocks
– An event that influences production capacity
and input costs, including labor costs,
examples include
•
•
•
•
•
Changes in the price or availability of imported oil
Freezes
Floods
Droughts
Changes in wage rates
– Negative supply shocks tend to result in
demand > supply, which is inflationary.
Negative supply shocks also may result in
reduced output, leading to slower economic
growth.
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Tie to investments
Choose industries that will be helped by
your expected economic scenario and
avoid those that will be hurt.
– For example, choose consumer cyclicals if
the economy is projected to do well, but not if
the economy will weaken,
– May choose consumer staples and
necessities such as utilities if the economy is
not expected to do well.
To earn abnormal returns you must
have better information (unlikely) or
better analysis than the competition.
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12.5 Federal Government
Policy
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Fiscal Policy
• Government spending and taxing actions
to stabilize or spur growth in the economy
– Most direct policy method in terms of its
effect on the economy (Keynesian policy)
– Often implemented too slowly due to political
process
– Leaky budget analogy
– Poor means to fine tune an economy, can be
inflationary
– May be necessary when monetary policy is
ineffective such as in the Financial Crisis of
2008
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Monetary Policy
• Manipulation of the money supply to
influence economic activity by
influencing the demand for goods and
services to be produced and consumed
– Initial & long run effects
– Potentially long lags
– Changes incentives to purchase and
invest, but may not lead to desired effect
on demand
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Monetary Policy
• Tools of monetary policy
– Open market operations (federal funds
rate)
– Discount rate
– Reserve requirements
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Supply-Side Policies
• Supply-siders focus on incentives and
marginal tax rates
• Lowering tax rates tends to
– encourage more investment
– Improve incentives to work
– generate faster economic growth
• “Lift all boats”
Can we rely solely on supply side
policies in a severe recession such as
the Financial Crisis of 2008?
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Supply-Side Policies
• Income inequality may also rise
– Those with better ideas, education,
opportunities, work ethic, providence,
etc. will do better, others may not.
– If the majority are better off, but some
much more so than others does this
indicate that we should not use supply
side policies?
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12.6 Business Cycles
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The Business Cycle
• Recurring patterns of recession and
recovery
– Peak
– Trough
• Industry relationship to business cycles
– Cyclical industries
• Industries with above average sensitivity to the
state of the economy
– Defensive
• Industries with below average sensitivity to the
state of the economy
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Economic Indicators
• Leading Indicators - tend to rise and fall
in advance of the economy
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Economic Indicators (cont)
• Coincident Indicators - indicators that
tend to change at the same time as the
economy
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Economic Indicators (cont)
• Lagging Indicators - indicators that
tend to follow or lag economic
performance
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Cyclical Indicators
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Other Indicators
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Figure 12.6 Economic Calendar at
Yahoo!
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12.7 Industry Analysis
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Industry Analysis
• Performance can vary widely across
industries
– It is difficult to find a good stock in a poor
industry
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Figure 12.8 Industry Stock Price
Performance, 2008
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Defining an Industry
• It can be difficult to define an industry
– North American Industry Classification
System (NAICS) attempts to define
industry groups with a four or five digit
code:
• The first two digits broadly define the industry
group: NAIC code 23 = construction
• The last two or three digits define the industry
more narrowly
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Example of NAICS Industry
Codes
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Figure 12.9 ROE of Application
Software Firms, 2008
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Sensitivity to Business Cycle
• Factors affecting sensitivity of earnings to
business cycles
– Sensitivity of sales of the firm’s product to the
business cycles
– Fixed costs and leverage
• Fixed costs are costs that do not vary with the level
of production.
• Fixed costs contribute to higher profitability when
sales are high, but will result in lower profitability
when sales are lower.
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Sensitivity to Business Cycle
– Operating leverage
• Proportion of fixed operating costs as a percent of
total costs
• Greater operating leverage results in greater
swings in profits over the business cycle
– Airlines, automobiles
– Financial leverage
• Proportion of fixed financing costs as a percent of
total costs
• Greater financial leverage results in greater swings
in profits over the business cycle
– Airlines, banks, investment banks
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Figure 12.10 Industry Cyclicality
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Figure 12.11 A Stylized Depiction
of the Business Cycle
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Sector Rotation
Selecting Industries in line with the stage
of the business
cycle:
natural
resource firms
defensive firms
• Peak
equipment, transportation and
• Contraction construction firms
• Trough
cyclical industries
• Expanding
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Figure 12.12 Sector Rotation
Illustrated
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Industry Life Cycles
Stage
Start-up
Consolidation
Maturity
Relative Decline
Sales Growth
Rapid & Increasing
Stable
Slowing
Minimal or Negative
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Figure 12.13 The Industry Life
Cycle
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Industry Structure and
Performance (Porter Model)
Determinants of Industry Competition and
Profitability
• Threat of Entry
– New entrants reduce profitability
– Barriers to entry preserve profitability
•
•
•
•
•
•
Large scale required to be profitable (autos)
Secure distribution channels
Brand loyalty, unique differentiated product
Proprietary production technology
Intellectual property protections
Learning curve effects
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Industry Structure and
Performance (Porter Model)
Determinants of Industry Competition and
Profitability
• Rivalry between existing competitors
– Equal competitors reduce profitability
– Slow industry growth,
Pressure to
– High fixed costs,
cut prices
– Scale economies,
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Industry Structure and
Performance (Porter Model)
Determinants of Industry Competition and Profitability
• Pressure from substitute products
– Substitutes limit profitability (propane, natural gas)
• Bargaining power of buyers
– A buyer that purchases a large percent of an
industry’s output can limit the selling industry’s
profitability (auto parts suppliers)
• Bargaining power of suppliers
– A supplier that controls a key input can limit the
buying industry’s profitability (labor unions)
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