by Industry analysis is a type of investment research that begins by focusing on the status of an industry or an industrial sector. A form of fundamental analysis involving the process of making investment decisions based on the different stages an industry is at during a given point in time. The type of position taken will depend on firm specific characteristics, as well as where the industry is at in its life cycle.
Industry Life Cycle Analysis
Many industrial economists believe that the development of almost every industry may be analyzed in terms of following stages:
- Pioneering stage: New technologies like personal computers or wireless communication portray the initial stages of an industry. At this stage, it is very difficult to anticipate which firms will succeed; some firms will be a total success while some might fail completely. Hence, the risk involved in selecting any specific firm in the industry is quite high at this stage. However, at this stage, since the new product has not yet flooded its market, there will be a rapid growth in sales and earnings at industry level. Like, for example, in 1980’s, personal computers were a part of very few houses, while on the other hand, products like fans or even refrigerators were part of almost every household. So naturally, the growth rate of products like refrigerators will be much less.
- Rapid growth stage: Once the product has proved itself in the market, several leaders in the industry start surfacing. The start-up stage survivors become more stable and market share can be easily envisaged. Thus, the performance of the industry in general will be more minutely tracked by the performance of the firms that have survived. As the product breaks through the market place and is used commonly, the growth rate of the industry is still faster than the rest of economy.
- Maturity and stabilization stage: The product has attained the full aptitude to be consumed at this stage by the users. So, any growth from this point just tracks the growth of the economy in general. At this stage, as the product gets more and more standardized, it compels the producers to compete heavily on price basis. As a result, the profit margins are lowered and add to the pressure on profits. Most often, firms at this stage are referred to as cash cows as their cash flows are quite consistent but offer very little opportunity for growth of profit. Instead of reinvesting the cash flows in the company, they are best milked from.
- Decline stage: In this stage following features are identified.
- Costs become counter-optimal
- Sales volume decline or stabilize
- Prices, profitability diminish
- Profit becomes more a challenge of production/distribution efficiency than increased sales.
Characteristics of An Industry Analysis
In an industry analysis, the following key characteristics should be considered by the analyst. These are explained as below:
- Post sales and Earnings performance: The historical performance of sales and earnings should be given due consideration, to know how the industry have reacted in the past. With the knowledge and understanding of the reasons of the past behaviour, the investor can assess the relative magnitude of performance in future. The cost structure of an industry is also an important factor to look into. The higher the cost component, the higher the sales volume necessary to achieve the firm’s break-even point, and vice-versa.
- Nature of Competition: The top firms in the industry must be analyzed. The demand of particular product, its profitability and price of concerned company scrip’s also determine the nature of competition. The investor should analyze the scrip and should compare it with other companies. If too many firms are present in the industry, this will lead to a decline in price of the product.
- Raw Material and Inputs: We need to have a look on industries which are dependent on raw material. An industry which has limited supply of raw material will have a less growth. Labor in also an input and problems with labor will also lead to growth difficulties.
- Attitude of Government towards Industry: The government policy with regard to granting of clearance, installed capacity and reservation of the products for small industry etc. are also factors to be considered for industry analysis.
- Management: An industry with many problems may be well managed, if the promoters and the management are efficient. The management has to be assessed in terms of their capabilities, popularity, honesty and integrity. A good management also ensures that the future expansion plans are put on sound basis.
- Labor Conditions and Other Industrial Problems: The industries which depend on labor, the possibility of strike looms as an important factor to be reckoned with. Certain industries with problems of marketing like high storage costs, high transport costs etc leads to poor growth potential and investors have to careful in investing in such companies.
- Nature of Product Line: The position of industry in the different stages of the life cycle is to be noted. And the importance attached by planning commission on these industries assessment is to be studied.
- Capacity Installed and Utilized: If the demand is rising as expected and market is good for the products, the utilization of capacity will be higher, leading to bright prospects and higher profitability. If the quality of the product is poor, competition is high and there are other constraints to the availability of inputs and there are labor problems, then the capacity utilization will be low and profitability will be poor.
- Industry Share Price Relative to Industry Earnings: While making investment the current price of securities in the industry, their risk and returns they promise is considered. If the price is very high relative to future earnings growth, the investment in these securities is not wise. Conversely, if future prospects are dim but prices are low relative to fairly level future patterns of earnings, the stocks in this industry might be an attractive investment.
- Research and Development: The proper research and development activities help in increasing economy of an industry and so while investing in an industry, the expenditure should also be considered.
- Pollution Standards: These are very high and restricted in the industrial sector. These differ from industry to industry, for example, in leather, chemical and pharmaceutical industries the industrial effluents are more.
