Macroeconomic and Industry Analysis CHAPTER 11 1 Framework
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Macroeconomic and Industry Analysis CHAPTER 11 1
Framework of Analysis n n Fundamental Analysis Approach to Fundamental Analysis ¨ Domestic and global economic analysis ¨ Industry analysis ¨ Company analysis n Why use the top-down approach
Global Economic Considerations Performance in countries and regions is highly variable n Political risk n Exchange rate risk n
Performance in countries n Countries Australia Belgium Canada France Italy Netherlands Sweden n n Growth in GDP(%) 2. 6 0. 7 1. 0 -0. 2 0. 5 -1. 1 2. 0 Countries Growth in GDPP(%) Austria Britain Denmark Germany Japan Spain U. S. Considerable variation in performance across countries expanding economies: more chance to succeed contracting economies: less chance to succeed Based on these performance, form expectation for your investment ¨ economies growing ¨ economies slowing down 0. 7 2. 0 -0. 8 -0. 2 1. 8 2. 4 3. 5
Political risk Consider 2 investors: A, an American wishing to invest in Indonesian stocks and an Indonesian wishing to invest in U. S. stocks Which one would face a more difficult task when doing macroeconomic analysis?
Exchange rate risk US investors: 2006: invest $1000 in Japan, exchange rate 1 USD = 100 Yen, $1000 is worth 100, 000 Yen In 2007: 1 USD = 110 Yen, 100, 000 Yen = 909 USD Lose $91
Domestic Economy n Gross domestic product ¨ n Unemployment rates ¨ n inflation is the rate at which the general level of prices is rising. High inflation is associated with overheated economy Trade-off between inflation and unemployment Budget Deficits ¨ n The ratio of number of people classified as unemployed to the total labor force Interest rates & inflation ¨ ¨ ¨ n Market value of goods and services produced over a period of time Government spending > government revenue Consumer sentiment ¨ consumers’ optimism and pessimism about the economy
Interest rate 4 Factors that can influence interest rates (1) Supply of fund (savers) (2) Demand of fund (borrowers) (3) Government net supply/fund (4) Expected inflation
Demand Supply Shocks n Demand shock - an event that affects demand for goods and services in the economy ¨ Tax rate cut ¨ Increases in government spending n Supply shock - an event that influences production capacity or production costs ¨ Commodity price changes ¨ Educational level of economic participants
Federal Government Policy n Fiscal Policy - government spending and taxing actions ¨ Increase spending: increase demand ¨ tax increase: reduce demand ¨ Net impact: n n budget deficit budget surplus
Federal Government Policy (cont. ) Monetary Policy - manipulation of the money supply to influence economic activity n Tools of monetary policy n ¨ Open market operations ¨ Discount rate ¨ Reserve requirements n If government wants to tighten money supply, what should it do?
Business Cycle
Business Cycles n Business Cycle ¨ Peak ¨ Trough n Industry relationship to business cycles ¨ Cyclical n above average sensitivity to states of economy ¨ Defensive n below sensitivity to states of economy
Business Cycles (examples) n At trough, right before recovery, one would expect cyclical industries to outperform others (economy increases (decreases) by 1%, the industry increases (decreases) by > 1%) ¨ Example: durable goods: auto, washing machine, financial industries ¨ Cyclical firms: betas > 1 or < 1, high or low betas? ¨ n Economy enters recession: cyclical or defensive ¨ example: food, public utilities, pharmaceutical ¨ Low or high betas? ¨ performance is stable, unaffected by market conditions ¨
NBER Cyclical Indicators: Leading Indicators - tend to rise and fall in advance of the economy Examples ¨ Avg. weekly hours of production workers ¨ Stock Prices ¨ Initial claims for unemployment ¨ Manufacturer’s new orders
NBER Cyclical Indicators: Coincident Indicators - indicators that tend to change directly with the economy Examples ¨ Industrial production ¨ Manufacturing and trade sales
NBER Cyclical Indicators: Lagging Indicators - indicators that tend to follow the lag economic performance Examples ¨ Ratio of trade inventories to sales ¨ Ratio of consumer installment credit outstanding to personal income
Industry Analysis Estimates of Earnings Growth Rates in Several Industries, 2004
Industry stock performance in 2003 Industry Telecommunication Pharmaceuticals Food products Insurance Health care Software Energy Retailing Entertainment Investment services Banking Wireless Communications technology Semiconductors n Stock return (%) 3. 6 7. 2 7. 7 16. 5 17. 7 21. 1 22. 9 28. 1 38. 2 40. 1 40. 5 49 79. 7 93. 9
Industry Analysis Sensitivity to business cycles n Sector Rotation n Industry life cycles n
Sensitivity to Business Cycle n Factors affecting sensitivity of earnings to business cycles ¨ Sensitivity of sales of the firm’s product to the business cycles ¨ Operating leverage ¨ Financial leverage
Figure 11. 9 Industry Cyclicality Sensitivity of sales of the firm’s product to the business cycles
Operating leverage n n Operating leverage = fixed cost / variable cost If operating leverage is high fixed cost dominates variable cost ¨ When economy changes, cost do not move enough to offset change in sale ¨ n n economy goes down, sale decreases, variable cost also decreases, but is dominated by fixed cost, total cost is quite stable, therefore, earning goes down more than the economy Sale increases, variable cost increases, but still dominated by fixed cost, total cost is quite stable, earning goes up more than economy Earning is very sensitive to economy If operating leverage is low: variable cost >> fixed cost sale goes down, total cost goes down ¨ sale goes up, total cost goes up ¨ earning is stable ¨
Financial leverage n n Use of borrowing Similar to fixed cost High financial leverage, earning is more sensitive to economy Low financial leverage, earning is more stable
Sector Rotation
Sector Rotation n n Selecting Industries in line with the stage of the business cycle Near peak – natural resource firms: Minerals, Gas, etc Contraction – defensive firms: food, pharmaceutical, etc. Trough – equipment, transportation and construction firms Expanding – cyclical industries: consumer durables, luxury items
Sector Rotation Gains
Industry Life Cycles Stage Sales Growth Start-up Consolidation Maturity Relative Decline Rapid & Increasing Stable Slowing Minimal or Negative
Figure 11. 11 The Industry Life Cycle
Industry Life Cycle n n n Example: VCR Start-up: new, so sale and earnings go up rapidly Consolidation stage: ¨ n product is established, more firms enter, growth rate is stable, and higher than economy Maturity stage product reach full potential use by consumers ¨ market is very competitive ¨ pay more dividends ¨ less on reinvestment ¨ n Relative decline new better products come in, e. g. , DVD ¨ Substitute for old products ¨
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