ASSIGNMENT OF SECURITY

ANALYSIS & PORTFOLIO

MANAGEMENT ON
INDUSTRY ANALYSIS

SUBMITTED TO: SUBMITTED BY:

PROF. HARPREET KAUR SHUBHAM SINGH
M.B.A II SEM 4th
ROLL NO. 21
 INDUSTRY ANALYSIS
After conducting an analysis of the economy and identifying the direction it is likely to take
in the short, interim and long-term, the analyst must look into various sectors of the economy
in terms of various industries. An industry is a homogenous group of companies. That is,
companies with similar characteristic can be divided into one industrial group. There are
many bases on which grouping of companies can be done.

Such a classification, through useful, does not help much in investment decision-making.
Some of the useful bases for classifying industries from the investment decision-point of
view are as follows:

Growth Industry: This is an industry that is expected to grow consistently and its growth
may exceed the average growth of the economy.

Cyclical Industry: In this category of the industry, the firms included are those that move
closely with the rate of industrial growth of the economy and fluctuate cyclically as the
economy fluctuates.

Defensive Industry: It is a grouping that includes firms, which move steadily with the
economy and less than the average decline of the economy in a cyclical downturn.

STAGES OF INDUSTRY LIFE CYCLE

Another useful criterion to classify industries is the various stages of their development.
Different stages of their life cycle development exhibit different characteristic. In fact, each
development is quite unique. Grouping firms with similar characteristics of development help
investors to properly identify different investment opportunities in the companies. Based on
the stage in the life cycle, industries are classified as follows:

1. Pioneering stage: This is the first stage in industrial life cycle of a new industry. In
this, technology and its products are relatively new and have not reached a stage of
perfection. There is an experimental order both in product and technology. However,
there is a demand for its products in the market; the profits opportunities are in plenty.
This is a stage where the venture capitalists take a lot of interest, enter the industry
and sometimes organize the business. At this stage, the risk commences in this
industry and hence, mortality rate is very high. If an industry withstands them, the
investors would reap the rewards substantially or else substantial risk of investment
exists. A very pertinent example of this stage of industry in India was the leasing
 industry, which tried to come up during the mid-eighties. There was a mushroom
growth of companies in this period. Hundreds of companies came into existence.
Initially, lease rental charged by them were very high. But as competition grew
among firms, lease rentals reduced and came down to Notes a level where it became
difficult for a number companies to survive. This period saw many companies that
could not survive the onslaught of competition of those firms that could tolerate this
onslaught of price war, could remain in the industry. The leasing industry today is
much pruned down compared to the mid-eighties.
2. Fast growing stage: This is the second stage when the chaotic competition and
growth that is the hallmark of the first stage is more or less over. Firms that could not
survive this onslaught have already died. The surviving large firms now dominate the
industry. The demand of their product still grows faster, leading to increasing amount
of profits the companies can reap. This is a stage where companies grow rapidly.
These companies provide a good investment opportunity to the investors. In fact, as
the firms during stage of development grow faster, they sometimes break records in
various areas, like payment of dividend and become more and more attractive for
investment.
3. Security and stabilization stage: The third stage where industries grow roughly at
the rate of the economy, develop and reach a stage of stabilization. Looked at
differently, this is a stage where the ability of the industry appears to have more or
less saturated. As compared to the competitive industries, at this stage, the industry
faces the problem of what Grodinsky called "latent obsolescence" a term used to a
stage where earliest signs of decline have emerged. Investors have to be very cautions
to examine those sings before it is too late.
4. Relative decline stage: The fourth stage of industrial life cycle development is the
relative decline The industry has grown old. New products, new technologies have
entered the market. Customers have new habits, styles, likes etc. The
company's/industry's products are not much in demand as was in the earliest stage.
Still, it continues to exist for some more time. Consequently, the industry would grow
less than the economy during the best of the times of the economy. But as is expected,
the industry's decline is much faster than the decline of the economy in the worst of
times.

The characteristics of different stages of life cycle development of industries have a number
of implications for decisions. Investment at this stage is quite rewarding. However, for an
investor looking for steady forms with risk aversion, it is suggested that he should in general
avoid investing at this stage. But if he is still keen to invest, he should try to diversify or
disperse his investment price the risk. It would be quite prudent on this part to look for
companies that are in the second date i.e., fast growth. This probably explains the prevalent
higher stock prices of the companies of this industry.

From the investment point of view, selection of the industries at the third stage of
development is quite crucial. It is the growth of the industry that is relevant and not its past
performance. There are a number of cases where the share prices of a company in a declining
industry have been artificially hiked up in the market, on the basis of its good performance.
But the fact of the matter is that a company in such an industry would sooner or later feel the
pinch of its decline and an investor investing in such companies experiences a reduction in
the value of his investment in due course.

Having discussed various investment implications, it may be pointed out that one should be
careful while classifying them. This is because the above discussion assumes that the investor
would be able to identify the industrial life cycle. In practice, it is very difficult to detect
which stage of the industry is at. Needless to say, it is only a general framework that is
presented above. One can spangle this analysis with suitable modifications. In order to
strengthen the analysis further, it is essential to outline the features of the industry in detail.
Due to its unique characteristic, unless the specific industry is analysed properly and in depth
with regard to these, it will be very difficult to form an opinion for profitable investment
opportunities.

1. There is competition among domestic and foreign firms, both in the domestic and the
foreign markets. How do firms perform here?

2. Many types of products are manufactured in this industry. Are these homogenous in nature
or highly heterogeneous?

3. What is the nature and prospect of demand for the industry? Are these homogenous in
nature or highly heterogeneous?

4. This may also incorporate the analysis of the markets of its products, customer-wise and
geographical area-wise, identifying various determinants of this type of industry its growth,
cyclical, defensive or relative decline industry

IMPORTANCE OF INDUSTRY ANALYSIS

Why should a security analyst carry out industry analysis?

To answer this question, logically, two arguments are presented:

1. Firms in each different industry typically experience similar levels of risk and similar
rates of return. As such, industry analysis can also be useful in knowing the
investment Worthiness of a firm.
2. 2. Mediocre stocks in a growth industry usually outperform the best stocks in a
stagnant industry. This points out the need for knowing not only company prospects
but also industry prospects.

Risk-return patterns: Economic theory points out that competitive firms in an industry try
to maximize their profits by adopting fairly similar policies with respect to the following:

1. The labour-capital ratio utilized by each firm.

2. Mark ups, profit margins and selling prices
3. Advertising and promotional programmes.
4. Research and development expenditures.
 5. Protective measures of the government.
At such, they have the same risk level as well as rates of return, on an average.
Empirical evidence shown by research done by Fabozzi and Francis supports this
argument.

Growth Factor: All industries do not have equally good or equally bad experiences
and expectations; their fortunes keep on changing. It implies that the past is not a
good indicator of the future – if one looks very far into the future.

This view is well supported by research. Researchers have ranked the performance of
different industries over a period of one year and then ranked the performance of the
same industries over subsequent periods of years. They compared the ranking and
obtained near zero correlations. It implies that an industry that was good during one
period of time cannot continue to be good in all periods.

Another observation is every industry passes through four distinct phases of the life cycle.
The stages may be termed as pioneering, expansion, stagnation and decline. Different
industries may be in different stages. Consequently their prospects vary. As such, separate
industry analysis is essential.

There are different ways of classifying industrial enterprises.

1. Classification by Reporting Agencies: In India, the Reserve Bank of India has
classified industries into 32 groups. Stock exchanges have made a broad
classification of industry into 10 groups.
Business media have their own classification. The Economic Times classifies
industry into 10 groups and the Financial Express into 19 groups. The groups are
further sub-divided.
2. Classification by Business Cycle: The general classification in this framework is
growth, cyclical, defensive and cyclical growth. Growth industries are
characterized by high rates of earnings expansion, often independent of business
cycles. These industries are pioneers of a major change in the state of the art i.e.,
innovation diffusing concerns. The ongoing revolution in the electronics industry
and communications equipments is an example of this kind.

Cyclical industries are closely related to business cycles. Prosperity provides consumers
purchasing power and boom to industry whereas depression adversely affects them.
Consumer durables are subject to these kinds of changes.

Defensive industries are those the products of which have relatively inelastic demand. Food
processing industry is an example.

Cyclical growth industries are those that are greatly influenced by technological and
economic changes. The airline industry can be cited as an example.