chapter16 - Chapter 16: Industry Analysis CHAPTER OVERVIEW...

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Unformatted text preview: Chapter 16: Industry Analysis CHAPTER OVERVIEW Chapter 16 covers industry analysis, the intermediate or second step in the fundamental analysis of common stocks which starts with market analysis and concludes with company analysis. As such, it is designed to cover the essentials of thinking about and analyzing industries without being overly technical. The philosophy behind Chapter 16 is important to note. Beginning students in Investments are unable to do detailed fundamental analysis, both because of knowledge limitations and time constraints. The author thinks it is unrealistic to ask students to do detailed industry analysis, involving tax rates, depreciation charges, and so forth. Therefore, the emphasis in Chapter 16 is on the conceptual issues: Why do we do industry analysis, what are the problems involved, and how should we conceptually go about doing industry analysis? In the final analysis, the point is made that industry analysis, like all aspects of fundamental analysis, comes down to estimating the future expected cash flows and discounting these cash flows at a proper discount rate, or using the estimated earnings for the industry next year and an appropriate P/E ratio. It is more important to get students to think about the conceptual issues involved in doing security analysis than in too many details of industry analysis that most will not understand or use again. Chapter 16 first documents the importance of industry analysis by showing how some industries outperform others over various time periods. There is no doubt that some industries outperform others over long periods of time. The discussion next demonstrates that short-term consistency is very difficult to find, which means that we cannot simply buy the industries that performed well last year and expect them to perform well this year. In many cases the opposite is true--bad performers for one year become good performers in the next year or the year after that. Therefore, investors interested in both long-term performance and shorter-term performance must do industry analysis. Chapter 16 also examines such issues as the definition of industries and the problem with classifying a particular company in one industry. The industry life cycle, which is often used as 16-1 part of industry analysis, is explained as a conceptual method of analyzing industries. The implications of business cycle analysis for industries are considered, which provides useful classifications for industries such as growth industries, defensive industries, cyclical industries, and interest-sensitive industries. Qualitative aspects of industry analysis are presented, including brief excerpts from the well-known Porter material on industry analysis. Two well-known diagrams from the Porter analysis on industries, one showing the five competitive forces that determine industry profitability and one showing the elements of industry structure, are included in the discussion. Once again, this analysis is consistent with the approach emphasized on...
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chapter16 - Chapter 16: Industry Analysis CHAPTER OVERVIEW...

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