INDUSTRY ANALYSIS

Concept Of Industry
An industry is generally described as a homogeneous group of companies/firms
producing reasonably similar products which serve the same needs of a common set of buyers.
An industry is a group of firms that have similar technological structure of production and produce similar
products.Industry Analysis refers to an evaluation of the relative strengths and weaknesses of particular
industries.

Classification Of Industries.
1.Food Products
2.Beverages,Tobacco and Tobacco products
3.Textiles
4.Wood and wood products
5.Leather and leather products
6.Rubber and plastic products
7.chemical and chemical products
8.Non-metallic mineral products
9.Basic metals, Alloys and metal products
10.Machinery and Machine Tools
11.Transport Equipment and parts
12.Other Miscellaneous Manufacturing Industries.

Industries can be classified according to their reactions to different phases of business cycle.

a)Growth
b)Cyclical
c)Defensive
d)Cyclical growth industry.

INDUSTRY LIFE CYCLE

The industry life cycle theory is generally attributed to Julius Grodinsky. According to this theory the life of an
industry can be divided into

1.The Pioneering stage

2.The expansion stage
3.The stagnation stage
4.The decay stage

PIONEERING STAGE

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a)This is the first stage of ILC
b)Technology as well as the product is new
c)Not reached a state of perfection.
d)Rapid Growth in demand for the output of the industry.
e)Great opportunity for profit.
f)When competition increases business mortality rate increases eliminating the weak firms.
g) Difficult for the analyst to identify which companies will survive.
h) Investment becomes highly risky.

i) Industries in the pioneering stage are called sunrise industries.

Expansion stage
This is the second stage of ILC
a) The industry includes only those companies that have survived the pioneering stage.
b) Companies continue to become stronger.
c) Competition among the surviving companies brings about improved products at lower prices.
d)Companies in the expansion stage of an industry are quite attractive for investment purposes.
e) Investors can get high returns at low risk as demand exceeds supply in this stage.
d)Companies in the expansion stage of an industry are quite attractive for investment purposes.
e) Investors can get high returns at low risk as demand exceeds supply in this stage.
STAGNATION STAGE
This is the third stage of ILC
a)The growth of the industry stabilizes.
b)Sales may be increasing but at a slower rate than competitors or overall economy.
c)The industry stagnates because of changes in social habits and development of improved technology.
d)An investor should dispose when industry enters stagnation stage.
DECAY STAGE
This is the last stage of ILC
a)products are no longer in demand
b)Entry of new products and new technology
c)change in customer tastes and preferences
d)Industry becomes obsolete.
e)Investor should get out before the onset of decay.
Pioneering stage---Low Profitability
Expansion stage---High Profitability
Stagnation stage--- Medium, but stable
Declining stage--- declining profitability.
Other Industry Variables
1) Growth Of The Industry
2) Cost Structure And Profitability
3) Nature Of The Product
4) Nature Of The Competition
5) Government Policy
6) Labor
7) Research And Development.
8) Pollution Standards
9) Supply Of Raw Materials
10) Permanence

Growth Of The Industry

Analyze Historical Performance of the industry in terms of growth and profitability.

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 Nature Of The Product
Determine whether the products are consumer goods or industrial goods. In case the goods are industrial
goods then analyse the demand for industrial goods by analyzing the conditions of the feeder industry as
well as the end user industry.

Government Policy
When selecting an industry government policy regarding that particular industry should be carefully
evaluated. Liberalisation and delicensing have brought immense threat to existing domestic industries in
several sectors.The major decisions of the Govt relating to the following factors are to be analysed.
#Tax Structure
#Export Import policy
#Price Control
#Production Control
#Entry barriers

Labour
The analysis of labor scenario in a particular industry is of great importance. The availability of labor and
also the trade unions existing in the industry are to be analyzed.

Research And Development

Any industry can survive in the global market only when it is technically competitive. The percentage of
expenditure on R&D should be studied diligently before making an investment.

Pollution Standards
The pollution standards applicable to the particular industry are to be analyzed.

Supply Of Raw Materials

Industry analysis must take into consideration the availability of raw materials and its impact on industry
prospects. some industries have to depend on imports for its raw materials and sometimes the suppliers are
few.
Cost Structure and profitability
The cost structure or the proportion of fixed and variable costs affects the cost of production and
profitability of the firm. Lower the fixed costs the easier it is to adjust to changing demand and to reach
breakeven point.

Permanence
Permanence is a phenomenon related to the products and the technology used by the industry. If an analyst
feels that the need for a for a particular industry will vanish or the products will become obsolete within a
short time it would be foolish to invest in such a industry.

Nature Of The Competition

The nature of competition is an essential factor that determines the demand for a particular product,its
profitability and the price of the scrip concerned.The analyser should analyse the following Competitive
Conditions In The Industry given by Porters five forces model.
1.Barriers TO Entry
2.Threat Of Substitution
3.Bargaining Power Of Buyers
4.Bargaining Power Of Suppliers
5.Rivalry Among Competitors

SWOT ANALYSIS
The investor should carry out SWOT analyses for the chosen industry.

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 Conclusion

If the Above factors indicate that the industry has favorable future funds may be committed to that
industry.

COMPANY ANALYSIS
Company analysis deals with the estimation of return and risk of individual shares.
Company analysis needs information
Information regarding companies can be broadly classified into two broad groups.
1.Internal information
2.External information

1.Internal information
Internal information sources consists of data and events made public by companies concerning their
operations.
ex- annual reports to shareholders,
the company’s financial statements etc.

2.External information
External sources of information are those generated independently outside the company. These are prepared
by the investment services and the financial press.

In Company analysis the analyst tries to forecast the future earnings of the company by assimilating several
bits of information relating to the company.

The company should be analyzed through the Qualitative factors and Quantitative factors.

Qualitative Factors Quantitative Factors

 Business Model  Earnings

 Management  Competitive edge
 Corporate Governance  Financial Leverage
 Corporate culture  Operational leverage
 Production Efficiency

Value Of Shares

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Qualitative Factors
1.Business Model
It provides a description of the companys operations and mode of revenue generation, nature of expenses
organizational structure and its sales and marketing efforts. The review of the business model reveals the
possible success level of the company.
2. Management
Good and capable management generates profit to the investors. The management of the firm should
efficiently plan, organize and control the activities of the company.
Good management should have the following traits as suggested by the Koontz and O’Donnell
-Ability to get along people
-Leadership
-Analytical competence
-Judgement
-Ability to get things done
3.Corporate Governance
Corporatev governance refers to the set of systems and practices put in place by a company to ensure
accountability, transparency, and fairness in dealings to safeguard the interests of the stakeholders.
Corporate governance typically covers the following areas.
@Structure Of Board Of Directors
@Financial And Information Transparency
@Stakeholder rights
Corporate Culture
Corporate culture refers to the Collective Beliefs Value systems and Processes of the company. A corporate
culture that values employees , customers and owners and encourages leadership from everyone in the
company.

The Quantitative factors to be considered in company analysis are

1.The competitive edge of the company
2.Earnings of the company
3.Capital structure of the company
4.Operating efficiency
5.Financial performance.
6.Production Efficiency
7.Productivity

THE COMPETITIVE EDGE

The competitive edge of the company can be determined through
*The market share
*The growth of annual sales
*The stability of annual sales
*Sales Forecast
The market share
If the market share is high the company would be able to meet the competition successfully.
Comparison should be made between the like/similar companies.
Growth of Annual Sales
The company may be a leading company, but if the growth in sales is comparatively lower than another
company, it indicates the possibility of the company losing the leadership.

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The rapid growth in sales would keep the shareholder in a better position than the one with a stagnant
growth.
The growth in sales of the company is analyzed both in rupee terms and physical terms.
Stability of sales
Sales should be stable both in absolute terms as well as its market share.
Investor can go for sales forecasting.

EARNINGS OF THE COMPANY

Sales alone do not increase the earnings but the costs and expenses of the company also influence the
earnings of the company.
Earnings do not always increase with increase in sales.
The company’s sales might have increased but its earnings per share may decline due to the rise in costs.
The investor should be aware that earnings of the company may vary due to
--change in sales
--change in costs
--Depreciation method adopted
--Depletion of resources
--Inventory accounting method
--Replacement cost of inventories
--Wages salaries
--Income taxes and other taxes.

CAPITAL STRUCTURE (DFL)

The analyst should investigate what is the debt equity composition in the capital structure of the company
The equity holders return can be increased manifold with the help of financial leverage.
During boom period –highly advantageous to equity holders
During recession—the leverage effect inducts instability in earnings per share and can lead to bankruptcy.

OPERATING EFFICIENCY (DOL)

The analyst should also analyse the cost structure of the company. He should analyse what is the fixed
component and what is the variable cost.
The operating efficiency of a company directly effects the earnings of the company.
An expanding company that maintains high operating efficiency with a low break even point earns more than
the company with the high break even point.

PRODUCTION EFFICIENCY
Production efficiency means producing maximum output at minimum cost.

PRODUCTIVITY
Productivity measures the relationship between inputs and outputs in a company

ANALYSIS OF FINANCIAL STATEMENTS

The financial statements of a company can be used to evaluate the financial performance of the company.
The two main statements used are
1.profit and loss account.
2.Balance sheet.

Approaches to financial analysis

1.Comparative financial statements

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2.Trend analysis
3.common size statements
4.Fund flow analysis
5.cash flow analysis
6.Ratio analysis

Ratio analysis
Ratio is a relationship between two figures expressed mathematically.

Financial ratios can be divided into six groups.

*Liquidity Ratios
*Turnover ratios
*Leverage ratios
*Profit Margin ratio
*Return on investment ratios
*Valuation Ratios
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Liquidity Ratio
These measure the company's ability to fulfill its short term obligations and reflect its short term financial
strength or liquidity.
1.Current ratio=
current assets/current liabilities

2.Quick (or Acid test)ratio=

current assets – Inventory-Prepaid expenses/current liabilities
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Turnover Ratios
These are also known as activity or efficiency ratios.These ratios tell how well the assets are used and the
extent of excess inventory ,if any.
1.Inventory Turn Over Ratio= Net sales/inventory
2. Receivables Turnover Ratio=Net sales/receivables
3.Fixed Turnover Ratio=Net sales/Fixed asset
4.Total Assets Turnover Ratio=Net Sales/Total Assets.
4.Current assets turnover= Sales/current assets
5.Debtors turnover= sales/Average debtors
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Leverage ratios
These ratios are also known as capital structure ratios. They measure the company's ability to meet its long
term obligation.The investors can find out the debt portion of the capital.
1.Debt equity ratio=Long term debt / shareholders equity.

2.Total debt ratio or debt to total assets ratio= coverage=total debt/total assets

3.Proprietary ratio=Shareholders equity/Total assets

4.Interest coverage ratio=EBIT/interest

These ratios indicate the relative contribution of owners and creditors in financing the assets of the company.

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These ratios reflect the safety margin available to the long term creditors. Interest coverage ratio measures
the ability of the company to meet its interest payments arising from the debt.
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PROFITABILITY RATIO
profitability ratios relate the firms profit with factors that generate the profits.These ratios help in knowing net
profit to sales, net profit to total assets and net profit to equity.

1. Net Profit Margin Ratio= PAT/Sales

2.Return On Assets = Net income/total assets
3.Return On Equity= Net profit/Net worth.
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VALUATION RATIOS
These ratios helps the investor to find out the value of the shares of the company.

Book Value per share=

Equity share capital+Reserve/total number of equity shares outstanding.
OR
Net worth-Preference share capital/ total number of equity shares outstanding

Dividend to market price

Dividend yield=dividend per share/market price per share *100

Earnings per share= EAT/number of shares outstanding.

Price earning ratio= market price per share/earnings per share.
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Assessment of Risk
Variability in returns is called as risk.Variability in returns arises mainly because of variability in sales.

The sensitivity of profits to changes in the level of sales is measured by a ratio called degree of total
leverage(DTL)

DTL=Contribution/PBT

WE KNOW That
DTL=DOL*DFL

=contribution/EBIT*EBIT/PBT
The degree of total leverage (DTL) is the product of DOL and DFL and measures the percentage change in PBT
for a one percent change in sales.

CONCLUSION

Company analysis deals with an analysis of various factors affecting the performance of companies so as to
forecast the future earnings of a company as also its variability better known as risk.

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