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Chapter 8
Economic & Industry Analysis
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Why a Three-Step
Valuation Approach?
General Economic Influences
Fiscal policy initiatives, such as tax credits or tax
cuts, can encourage spending
Monetary policy though controlling money supply
growth or interest rate therefore affects all
segments of an economy and that economys
relationship with other economies
Continued
Copyright 2010 by Nelson Education Ltd.
8-6
Why a Three-Step
Valuation Approach?
General Economic Influences
Inflation causes changes the spending and
savings behaviour of consumers and corporations
Other events such as war, political upheavals in
foreign countries, or international monetary
devaluations exert strong effects on the
economies
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Why a Three-Step
Valuation Approach?
Industry Influences
Identify global industries that will prosper or
suffer in the long run or during the expected
near-term economic environment
Different industries react to economic changes at
different points in the business cycle
Continued
Copyright 2010 by Nelson Education Ltd.
8-8
Why a Three-Step
Valuation Approach?
Industry Influences
Alternative industries have different responses to
the business cycle
Demographic factor and international exposure
will also have different impacts on different types
of industries
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Why a Three-Step
Valuation Approach?
Company Analysis
The purpose of company analysis to identify the
best companies in a promising industry
This involves examining a firms past
performance, but more important, its future
prospects
Continued
Copyright 2010 by Nelson Education Ltd.
8-10
Why a Three-Step
Valuation Approach?
Company Analysis
It needs to compare the estimated intrinsic value
to the prevailing market price of the firms stock
and decide whether its stock is a good investment
The final goal is to select the best stock within a
desirable industry and include it in your portfolio
based on its relationship (correlation) with all
other assets in your portfolio
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Economic Analysis:
Understanding Business Cycles
Leading Indicators:
Economic series
that usually reach
peaks or troughs
before
corresponding
peaks or troughs in
aggregate economy
activity
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Economic Analysis:
Understanding Business Cycles
Coincident Indicators:
Economic series that have peaks and troughs that
roughly coincide with the peaks and troughs in the
business cycle
Lagging Indicators:
Economic series that experience their peaks and
troughs after those of the aggregate economy
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Economic Analysis:
Composite Leading Indicator Series
Developed by
Statistics Canada
Overall gauge of
the future
direction of the
Canadian
economy
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Economic Analysis:
Inflation, Interest Rates, & Stock Prices
Inflation and Interest Rates
Generally move together
Investors are not good at predicting inflation
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Economic Analysis:
Inflation, Interest Rates & Stock Prices
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Industry Analysis
What is an Industry?
Identifying an industry can be difficult
Clearly airlines, railroads and utilities are easy to
categorize
How do we deal with manufacturing firms that
have three different divisions none of which are
dominant?
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Characteristics of an Industry
Price History
Price History
P/E ratios
Common Stock Yields
Price/Book Ratios
Price/Cash Flow Ratios
Price/sales Ratios
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Characteristics of an Industry
Operating Data & Results
Operating Data
Comparative Results
Return on Investment
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Interest Rates
For example, financial and housing industries
will be adversely affected by high interest rates
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Consumer Sentiment
The performance of consumer cyclical
industries will be affected by changes in
consumer sentiment
Copyright 2010 by Nelson Education Ltd.
8-28
Technology
Politics and Regulations
Economic reasoning
Fairness
Regulatory changes affect numerous industries
Regulations affect international commerce
Copyright 2010 by Nelson Education Ltd.
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Technology
Politics and Regulations
Economic reasoning
Fairness
Regulatory changes affect numerous industries
Regulations affect international commerce
Copyright 2010 by Nelson Education Ltd.
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