Economic and Industry Analysis

Framework of Analysis
Fundamental Analysis
Approach to Fundamental Analysis:
Domestic and global economic analysis
Industry analysis
Company analysis
 Fundamental Analysis
Company Analysis
The Analysis of
economy, industry and
Industry analysis
company constitute the
main activity in the
Economy Analysis
fundamental approach
to security analysis.
And can be viewed as
different stages in
investment decision
making process. Three tier analysis depict
that company
performance dependent
not only on its own effort
but also on the general
industry and economy
factor.
Economy Analysis
Boom Economy:
Income rise and demand for goods will increase the industries

and companies in general tend to be prosperous.

Recession Economy:
Income decline and demand for goods will decrease the industries
and companies in general tend to be bad performance
 Researchers have found that stock price changes can be
attributed to the followings factors.
Economy wide factors; 30-35 percent
Industry factors; 15-20 percent
Company factors 30-35 percent
Others factors 15-20 percent
Business Cycles
 The Domestic Macro economy

The macro economy is the environment in which all firms operate.

Key economic statistics used to describe the state of the economy:

1. Government Policy
2. Gross domestic product
3. Industrial Growth Rate
4. Agriculture and Monsoon
5. Inflation
6. Interest rates
7. Budget deficit
8. Sentiment
9. Foreign exchange (Global Economy)
Government Policy
Fiscal Policy

The government changing the levels of spending and tax actions in order to
influence aggregate demand
Decrease in government spending decrease the demand for goods and services
while increase in tax rates decrease the income of consumers (households).
If budget deficit>0 then government spend more than it earns and stimulate the
economy.

The purpose of Fiscal Policy

Stimulate economic growth in a period of a recession.
Keep inflation low
fiscal policy aims to stabilize economic growth, avoiding a boom and bust economic
cycle.
Government Policy
Monetary Policy

The change in money supply to affect the macro economy.

There are two types of Monetary Policy:

Expansionary
It lowers the interest rates and cause an increase in investment and consumption
demand.

Contractionary
It increases the Interest rates.
Tools of Monetary Policy

A) Open Market Operations

B) Bank Rate
C) Reserve Requirements
D)Direct Credit Control

Buying and selling of government securities by RBI includes open market operations
Bank rate is the rate at which RBI provides long term loan to banks.
Reserve requirements are in the form of CRR (Cash Reserve ratio) and SLR(Statutory
Liquidity ratio)
Direct control by asking banks to lend a certain percentage of funds to priority sectors.
GDP
GDP indicates the rate of growth of the economy. It is
one measure of economic activity.

This is the total amount of goods and services produced in a

country in a year. It is calculated by adding the market values
of all the final goods and services produced in a year

Rapid growth in GDP indicates an expanding economy and

higher sales for the firms.
Industrial Growth Rate
Industrial production (IP): another measure of total output. It focuses on the
manufacturing side of the economy

The growth rate of economy points out the prospects for the industrial sector and the
return investors can expect from investment in shares.

The higher growth rate is more favorable to the stock market.

 Agriculture and Monsoon
Indian economy depends on agriculture sectors, the economy also depends on
the performance of agriculture, optimistic forecasting of weather condition
will prosper the economy condition.

Weather forecasting becomes a matter of great concern for investor in the

economy of agricultural country.

Companies using Agricultural raw materials as inputs or supplying inputs to

agriculture are affected directly.
Saving and Investments
Level of Investment in the economy = Domestic savings+ Inflow of foreign
capital- Investments made abroad.

Higher the level of savings and investments, greater the allocation of same to
equities.
 Budget Deficit

The difference between government spending and revenues.

In India, Government revenues come more from indirect taxes such as excise
duty, custom duty and less from direct taxes such as Income Tax.

Bulk of earnings goes towards administration, interest payment, defense and

subsidies.

The excess of expenditure represents deficit. The deficit should be closed by

borrowing.

The government borrowing can be from Reserve bank of India(RBI),

borrowing in domestic Capital market or from abroad.
Inflation
The rate at which the general level of prices rise.

High rates of inflation are associated with overheated economies.

There is a trade-off between inflation and unemployment

Along with the growth of GDP, if the inflation rate also increases, then the real
growth would be very little.

The effects of inflation on capital markets are numerous. An increase in the

expected rate of inflation is expected to cause a rise in interest rates. Also, it
increases uncertainty of future business and investment decisions.

As inflation increases, it results in extra costs to businesses, thereby squeezing their

profit margins and leading to real declines in profitability
Interest Rates

Determinant for business investment expenditures.

As interest rates increases the investment decreases

so does the economic growth
Balance of Payments

Balance of payments Deficit = Balance of trade deficit(Imports minus Exports)

+Balance on invisibles such as tourism etc
+ Balance on account of capital transactions.

Balance of payment deficit depletes the forex reserves of the country

which impacts the economy.
Foreign Investment

Foreign Investment can be in two forms

A) Foreign Direct Investment(FDI)

B) Foreign Portfolio Investment by FIIs

Both of them act as a powerful force in affecting Indian Capital market.

Sentiments

Beliefs (optimism and pessimism) of consumers and producers

influence the levels of consumption and production and affect the
aggregate demand for goods and services.

Higher Confidence leads to higher Expenditures.

Industry Analysis
Basic Industry Analysis

A) Industry Life Cycle Analysis.

B) Study of the Structure and Characteristics of an Industry.
C) Profit Potential of Industries: Porter Model.
Industry Analysis
Key factors
1. Past performance of the industry
2. The permanence of the product and technology of the
industry
3. Role of government in the industry
4. Labour conditions relating to industry
5. Competitive conditions
6. Inter-linkage with other industries.
Porter Model

Porters (1985) determinants of competition

Threat of entry
1. High prices and profit margins will encourage entry by new competitors.
2. Barriers to entry is a key determinant of industry profitability
3. High switching Costs.
4. Brand loyalty
5. Patent protection
6. Experience in the market
Rivalry between existing competitors
1. More price competition and lower profit margin
2. Number of competitors are large
3. Slow industry growth
4. High fixed costs
5. Chronic Over capacity
6. High Exit barriers.
Porter Model
Pressure from substitute products
1. Availability of substitutes limits the prices that can be charged.

Bargaining power of buyers

1. If a buyer purchases a large fraction of an industrys output, it will have considerable
bargaining power and ask for price reductions and reduces the profitability of the
supplier.
2. Low switching costs for buyers
3. Threat of backward Integration.

Bargaining power of suppliers

1. If a supplier of a key input has monopolistic control over the product, it can demand
higher prices for the good and decrease the profits of the industry
2. Switching costs for the buyers are high.
Forces Driving
Industry Competition
 Industry Life Cycles

The industry life cycle might be described as four stages:

Start-up stage:

Characterized by extremely rapid growth of sales and earnings

Early stages of an industry
New technology
Difficult to predict which firms are going to be leaders.
Some will be very successful some will fail.

Consolidation stage/Growth Stage

Characterized by growth that is less rapid but still faster than the general economy
Industry leaders begin to emerge
Survivors from the start-up stage are more stable and the performance of the survivors closely track
the performance of the industry
Industry Life Cycles
Maturity stage

Characterized by the growth no faster than the general economy

The product has reached its full potential for use by the consumers.
Producers compete on the basis of price
Narrow profit margins

Relative decline stage

Characterized by the growth less rapidly than the rest of the economy
The product become obsolete
Competition from new low-cost suppliers (or new products).

Generally industries at the high-growth stages are more attractive for investment unless the
stock prices already reflects likelihood for high growth
Figure 17.11 The Industry Life Cycle