It could be of course that the firm has made changes

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Unformatted text preview: Based on this, we might wonder if the liquidity position of the firm has deteriorated. It could be, of course, that the firm has made changes that allow it to more efficiently use its current assets, that the nature of the firm’s business has changed, or that business practices have changed. If we investigate, we might find any of these possible explanations behind the decline. This is an example of what we mean by management by exception—a deteriorating time trend may not be bad, but it does merit investigation. PEER GROUP ANALYSIS The second means of establishing a benchmark is to identify firms similar in the sense that they compete in the same markets, have similar assets, and operate in similar ways. In other words, we need to identify a peer group. There are obvious problems with doing this since no two companies are identical. Ultimately, the choice of which companies to use as a basis for comparison is subjective. One common way of identifying potential peers is based on Standard Industrial Classification (SIC) codes. These are four-digit codes established by the U.S. government for statistical reporting purposes. Firms with the same S IC code are frequently assumed to be similar. The first digit in an SIC code establishes the general type of business. For example, firms engaged in finance, insurance, and real estate have SIC codes beginning with 6. Each additional digit narrows down the industry. So, companies with SIC codes beginning with 60 are mostly banks and banklike businesses, those with codes beginning with 602 are mostly commercial banks, and SIC code 6025 is assigned to national banks that are members of the Federal Reserve system. Table 3.7 is a list of selected two-digit codes (the first two digits of the four-digit SIC codes) and the industries they represent. SIC codes are far from perfect. For example, suppose you were examining financial statements for Wal-Mart, the largest retailer in the United States. In a quick scan of the nearest financial database, you would find about 20 large, publicly owned corporations with the same (or very close) SIC code as Wal-Mart, but you might not be too comfortable with some of them. Target might seem to be a reasonable peer, but Neiman Marcus would also show up. Are Wal-Mart and Neiman Marcus really comparable? As this example illustrates, it is probably not appropriate to blindly use SIC code– based averages. Instead, analysts often identify a set of primary competitors and then compute a set of averages based on just this group. Also, we may be more concerned with a group of the top firms in an industry, not the average firm. Such a group is called an 60 PART 1 Overview ros82361_ch03.indd ros82361_ch03.indd 60 5/27/08 10:15:02 AM Confirming Pages TA B LE 3. 7 Selected Two-Digit SIC Codes AGRICULTURE, FORESTRY, AND FISHING 01 Agriculture production—crops 08 Forestry 09 Fishing, hunting, and trapping MINING 10 Metal mining 12 Bituminous coal and lignite mining 13 Oil and gas extraction CONSTRUCTION 15 Building construction 16 Construction other than building 17 Construction—special trade contractors MANUFACTURING 28 Chemicals and allied products 29 Petroleum refining and related industries 35 Machinery, except electrical 37 Transportation equipment TRANSPORTATION, COMMUNICATION, ELECTRIC, GAS, AND SANITARY SERVICE 40 Railroad transportation 45 Transportation by air 49 Electric, gas, and sanitary services WHOLESALE TRADE 50 Wholesale trade—durable goods 51 Whole...
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This note was uploaded on 10/28/2009 for the course FINA 505 taught by Professor Deborahcernauskas during the Summer '09 term at Northern Illinois University.

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