the top-down approach to market, industry, and company analysis (Chapter 9)

market analysis

examine the attractiveness of a particular market

macroanalysis of the relationship between the aggregate securities markets and the aggregate economy

specific micro valuation of the stock market employing the valuation approaches

indicators

coincident indicators

lagging indicators

leading indicators

reach peaks or troughs before corresponding peaks or troughs in aggregate economic activity

have peaks or troughs that roughly coincide with the peaks and troughs in the business cycle

experience their peaks and troughs after those of the aggregate economy

microvaluation analysis: calculate an actual estimate of the value of the market

free cash flow to the equityholder (FCFE) model

relative valuation

estimate of next year's cash flows

discount rate

interest expense
-interest expense - operating profit

tax rate

operating margin
-operating profit = sales per share x operating margin

discount rate

growth rate of sales per share

industry analysis

structural impacts

life cycle of the industry

cyclical impacts

competitive forces within an industry (Porter analysis)

*business cycle

recession (contracts)

recovery (recovers from the prior expansion to reach the prior peak)

peaks

expansion (grows further)

*sector rotation
-monitor economic trends
-attempt to move their investments from one sector (or industry within a sector) to another sector (or industry) as economic trends change

financial firms: contraction induce lower inflation and interest rates

investors prefer materials and technology industries

cyclical industries: consumer durables, luxury items

equipment manufacturers become attractive as modernising, renovating, and buy new equipment will be more

consumer staples: food, beverages, pharmaceuticals become better as it is necessity

expect defensive industries that are less sensitive to economic conditions

capital goods (physical assets that a company uses in the production process to manufacture products and services

lifestyles

technology

demographics

politics and regulation

rapid accelerating growth

mature growth

pioneering development

stabilisation/market maturity

deceleration of growth / decline

birth

adolescence

adulthood

middle age

old age

-market for product or service is small
-modest sales growth
-negative profits (major development costs)

-market develops and becomes substantial
-sales grow at increasing rate
-limited competition (high margins)
-profits explode

-sales growth no longer accelerating
-growth may be higher than GDP
-high margins attract competitors
-profit margins begin to decline

-growth declines to GDP growth rate
-profit margins vary by industry
-controlling costs becomes more important
-competition and low margins brings returns on capital down to cost of capital

-sales growth declines due to shifts in demand or substitutes
-profit margins squeezed
-low profits or losses
-low returns on capital

bargaining power of buyers

bargaining power of suppliers

threat of new entrants

threat of substitute products or services

rivalry among existing firms

increases if:
-equal size companies
-slow growth
-high fixed costs
-exit barriers

increases if:
-large profit potential
-substitutes that are close in price or function
-more commodity-like product or service

increases if:
-fewer suppliers
-seller industry is more concentrated than buyer industry
-supplier supplies critical input
-supplier sells to several industries
-few substitutes

increases if:
-buyer accounts for large % of your sales
-buyer has knowledge of seller's profits
-product accounts for large % of buyer's cost
-many sellers

increases with low barriers to entry:
-high profit margins
-small financial resources needed to compete
-no economies of scale
-distribution channel that is easy to build
-low switching costs
-no government licensing requirements
-unlimited access to materials

global industry analysis

final questions in the fundamental analysis procedure

intrinsic value of the firm's stock

intrinsic value compare with the market value

best companies within desirable industries

firm competitive strategies

low cost strategy

differentiation

offensive

focusing a strategy

defensive

tenets of warren buffet

management tenets

financial tenets

business tenets

market tenets

does the business have a consistent operating history

does the business have favourable long-term prospects

is the business simple and understandable

is management candid with its shareholders

does management resist the institutional imperative

is management rational

calculate owner earnings

look for companies with high profit margins

focus on return on equity

for every dollar retained, make sure the company has created at least one dollar of market value

what is the intrinsic value of the business

can the business be purchased at a significant discount to its fundamental intrinsic value