Fundamental Analysis

Part - II

Industry Analysis
What is an Industry?
◎ An industry is a group of companies that have similar
technological structure of production and produce similar
products.

◎ Individual companies are generally classified into an industry

based on their largest sources of revenue.

◎ Industry grouping is based on the primary product that a company

makes and sells. Meanwhile, industries are grouped together into
sectors.

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 Industry Classification
◎ Industry classification is also used by securities analysts to
understand common forces acting on groups of companies, to
compare companies' performance to their peers', and to construct
either specialized or diversified portfolios.
◎ These industries can be classified on the basis of business cycle
i.e., classified according to how they react to the different phases
of their business cycle.
◎ They are classified into growth, cyclical, defensive and cyclical
growth industry.

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 Growth Industry
◎ A growth industry is that sector of an economy which experiences a
higher-than-average growth rate as compared to other sectors / overall
market.
◎ Growth industries are often new or pioneer industries that did not exist
in the past. Their growth is a result of demand for new products or
services offered by companies in the field.
◎ An example of a growth industry is the technology sector, whose
products have become runaway hits with consumers and led to
multibillion-dollar valuations for tech companies in the stock market.

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 Cyclical Industry
◎ A cyclical industry is a type of industry that is sensitive to the 
business cycle, such that revenues generally are higher in periods of
economic prosperity and expansion and are lower in periods of
economic downturn and contraction.
◎ Companies in cyclical industries can deal with this type of volatility by
implementing employee layoffs and cuts to compensate during bad
times and paying bonuses and hiring en masse in good times.

◎ For example, the white goods like fridge, washing machine and kitchen
range products command a good market in the boom period and the
demand for them slackens during the recession
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 Cyclical vs. Non-Cyclical
◎ The terms cyclical and non-cyclical refer to how closely correlated a company's
share price is to the fluctuations of the economy.
◎ Cyclical stocks have a direct relationship to the economy, they are volatile and
tend to follow trends in the economy while non-cyclical stocks repeatedly
outperform the market when economic growth slows.
◎ Investors cannot control the cycles of the economy, but they can tailor their
investing practices to its ebb and flow.
◎ Companies of cyclical stocks sell goods and services that many buy when the
economy is doing well but cut during downturns.
◎ Non-cyclical companies sell household, non-durable goods like soap and
toothpaste and their stocks are called defensive stocks.

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 Defensive Industry
◎ Defensive industries comprise businesses that are relatively stable or
relatively immune to economic fluctuations, i.e., economic expansions
and recessions. Defensive industry defies the movement of the business
cycle.
◎ The industry usually consists of businesses dealing in necessity goods
e.g. food and shelter. The food industry withstands recession and
depression.
◎ The stocks of the defensive industries can be held by the investor for
income earning purpose. They expand and earn income in the
depression period too, under the government’s umbrella of protection
and are counter cyclical in nature.
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 Cyclical Growth Industry
◎ This is new type of industry that is cyclical and at the same
time growing.
◎ For example, the automobile industry experiences periods of
stagnation, decline but then they again revive and grow
tremendously.
◎ The change in technology and introduction of new models
help the automobile industry to resume their growth path.

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Industry Life Cycle

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 1. Introduction Stage
◎ The prospective demand for the product is promising in this stage and the
technology of the product is low.
◎ The demand for the product attracts many producers to produce the particular
product. There would be severe competition and only fittest companies survive
this stage.
◎ The producers try to develop brand name, differentiate the product and create a
product image. This would lead to non-price competition too.
◎ The severe competition often leads to the change of position of the firms in terms
of market shares and profit.
◎ In this situation, it is difficult to select companies for investment because the
survival rate is unknown.

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 2. Growth Stage
◎ This stage starts with the appearance of surviving firms from the
introduction stage. The companies that have withstood the competition
grow strongly in market share and financial performance.

◎ The technology of the production would have improved resulting in low

cost of production and good quality products.

◎ The companies have stable growth rate in this stage and they declare
dividend to the share holders. It is advisable to invest in the shares of
these companies.

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 3. Maturity Stage
◎ In this stage, the growth rate tends to moderate and the rate of growth
would be more or less equal to the industrial growth rate or the gross
domestic product growth rate.
◎ Symptoms of obsolescence may appear in the technology. The keep
going, technological innovations in the production process and products
should be introduced.

◎ The investors have to closely monitor the events that take place in the
maturity stage of the industry in order to shift their investment in some
growth stage companies.

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 4. Declining Stage
◎ In this stage, demand for the particular product and the earnings of the
companies in the industry decline. Innovation of new products and
change in consumer preferences lead to this stage e.g. with the
introduction of flat screen T.V. the old style T.V. are out.
◎ The specific feature of the declining stage is that even in the boom
period; the growth of the industry would be low and decline at a higher
rate during the recession.

◎ It is better to avoid investing in the shares of the low growth industry

even in the boom period. Investment in the shares of these types of
companies leads to erosion of capital
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 Additional Factors to be Considered
◎ Apart from industry life cycle analysis, the investor has to analyze some
other factors too. They are as listed below
➢1. Growth of the industry
➢ 2. Cost structure and profitability
➢ 3. Nature of the product
➢ 4. Nature of the competition
➢ 5. Government policy
➢6. Labor
➢ 7. Research and Development
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 1. Growth of the Industry
◎ The historical performance of the industry in terms of growth and
profitability should be analyzed.
◎ Industry wise growth is published periodically by Economic Survey of
Pakistan.
◎ The past variability in return and growth in reaction to macro economic
factors provide an insight into the future. Even though history may not
repeat in the exact manner, looking into the past growth of the industry,
the analyst can predict the future.
◎ The information technology industry has witnessed a tremendous
growth in the past so also the scrip prices of the IT industry.

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 2. Cost Structure and Profitability
◎ The cost structure, that is the fixed and variable cost, affects the cost of
production and profitability of the firm.
◎ In the case of oil and natural gas industry and iron and steel industry the
fixed cost portion is high and the gestation period is also lengthy.
◎ Higher the fixed cost component, greater sales volume is required to
reach the firm’s breakeven point. On reaching the breakeven point, the
profitability can be increased by utilizing the capacity to full.

◎ Once the maximum capacity is reached, again capital has to be invest in

the fixed equipment to increase profitability.
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 3. Nature of the Product
◎ The products produced by the industries are demanded by the consumers and
other industries. If industrial goods like pig iron, iron sheet and coils are
produced, the demand for them depends on the construction industry. Likewise,
textile machine tools industry produces tools for the textile industry and the
entire demand depends upon the health of the textile industry.
◎ The investor has to analyze the condition of related goods producing industry
and the end user industry to find out the demand for industrial goods.
◎ In the case of consumer goods industry, the change in the consumers’ preference,
technological innovations and substitute products affect the demand. A simple
example is that the demand for the ink pen is affected by the ball point pen
(change in consumer preference)

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 4. Nature of the Competition
◎ Nature of competition is an essential factor that determines the demand for the
particular product, its profitability and the price of the concerned company
shares.
◎ Suppliers may be local producers or multinationals. For instance a detergents, is
produced by indigenous manufactures and distributed locally at a competitive
price. There is a threat of multinational entering into the field with better quality
product. Now the companies’ ability to withstand the local as well as the
multinational competition counts. If many firms are present in the industry, the
competition would be severe, which would lead to a decline in the price of the
product and eventually the profit margins.
◎ The investor should analyze the market share of the particular company’s product
and should compare it with the top five companies.
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 5. Government Policy
◎ Government policies affect the very nerve of the industry and
inconsistent government polices damage the companies badly.
◎ Tax subsidies and tax holidays are provided for export oriented products.
◎ Government regulates the size of the production and the pricing of
certain products.
◎ In some cases entry barriers are placed by the government which leads
to monopoly.
◎ When selecting an industry, the government policy regarding the
particular industry should be carefully evaluated. Liberalization and de-
licensing are great threats to the existing domestic industries.

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 6. Labor
◎ The analysis of labor scenario in a particular industry is of great
importance. The number of trade unions and their operating mode has
impact on the labor productivity and modernization of the industry. If the
trade unions are strong and strikes occur frequently, it would lead to fall
in the production. In an industry of high fixed cost, the stoppage of
production may lead to loss.
◎ Investor should also the labor protection laws in that industry which
gives them immense power to shut the production.
◎ In developing countries skilled and well-qualified labor is available at a
cheaper rate. This is one of the many reasons attracting the
multinationals to set up companies in Pakistan.

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 7. Research and Development
◎ For any industry to survive the competition in the national and
international markets, product and production process have to be
technically competitive.
◎ This depends on the R & D in the particular company or industry.
◎ Companies can only survive, maintain their market share, achieve
economies of scale and enter new market only when they believe in
innovation and invest in R & D.
◎ Percentage of expenditure made on R & D should be studied diligently
before making an investment.

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 Compliance with International Standards
◎ Certain companies cannot enter into international trade only because
they do not comply with the international standards and hence have a
great to their growth.
◎ The standards may relate to the following;
◎ Accounting Standards – IFRS
◎ Auditing Standards
◎ ISO – 9000 Standards
◎ Labor Standards
◎ Pollution standards

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Industry Analysis

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What is Industry Analysis?
◎ Industry analysis is a market assessment tool used by businesses and
analysts to understand the competitive dynamics of an industry. It helps
them to know what is happening in an industry, e.g., 
◎ Demand-Supply statistics,
◎ Degree of competition within the industry, 
◎ State of competition of the industry with other emerging industries,
◎ Future prospects of the industry studying the technological changes,
◎ Credit system (availability) within the industry, and
◎ Influence of external factors on the industry.

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 What is Industry Analysis?
◎ Industry analysis, is a method that helps to understand a
company’s position relative to other participants in the industry.
◎ It helps them to identify both the opportunities and threats
coming their way and gives them a strong idea of the present and
future scenario of the industry.
◎ The key to surviving in this ever-changing business environment is
to understand the differences between yourself and your
competitors in the industry and use it to your full advantage.

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Types of industry analysis
◎ There are three commonly used and important
methods of performing industry analysis.
◎ The three methods are:
◎ Competitive Forces Model (Porter’s 5 Forces)
◎ Broad Factors Analysis (PEST Analysis)
◎ SWOT Analysis
◎ 

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1. Competitive Forces Model (Porter’s 5 Forces)

◎ One of the most famous models ever

developed for industry analysis, famously
known as Porter’s 5 Forces, was introduced
by Michael Porter in 1980.

◎ According to Porter, analysis of the five

forces gives an accurate impression of the
industry and makes analysis easier.

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1. Intensity of industry rivalry
The number of participants in the industry and their respective market shares
are a direct representation of the competitiveness of the industry. Lack of
differentiation in products tends to add to the intensity of competition. High
exit costs such as high fixed assets, government restrictions, labor unions, etc.
also make the competitors fight the battle a little harder.
2. Threat of potential entrants
This indicates the ease with which new firms can enter the market of a
particular industry. If it is easy to enter an industry, companies face the constant
risk of new competitors. If the entry is difficult, whichever company enjoys little 
competitive advantage reaps the benefits for a longer period. Also, under
difficult entry circumstances, companies face a constant set of competitors.

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3. Bargaining power of suppliers
If the industry relies on a small number of suppliers, they enjoy a
considerable amount of bargaining power. This can particularly affect
small businesses because it directly influences the quality and the price
of the final product.

4. Bargaining power of buyers

The complete opposite happens when the bargaining power lies with
the customers. If consumers/buyers enjoy market power, they are in a
position to negotiate lower prices, better quality, or additional services
and discounts. This is the case in an industry with more competitors but
with a single buyer constituting a large share of the industry’s sales.

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5. Threat of substitute goods/services
The industry is always competing with another industry
producing a similar substitute product.
Hence, all firms in an industry have potential competitors from
other industries. This takes a toll on their profitability because
they are unable to charge exorbitant prices.

◎ Substitutes can take two forms – products with the same

function/quality but lesser price, or products of the same price
but of better quality or providing more utility.

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 2. Broad Factors Analysis (PEST Analysis)
◎ Broad Factors Analysis, commonly called the PEST Analysis, is a key
component of external analysis.

◎ A Broad Factors Analysis assesses and summarizes the four macro-

environmental factors — political, economic, socio-demographic
(social), and technological.

◎ These factors have significant impacts on a business’s operating

environment, posing opportunities and threats to the company and all
of its competitors.
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 Political Factors
◎ Political factors refers to the regulatory environment of a particular industry or
business.
◎ Political factors can constrain the operations of organizations and introduce
opportunities and threats to companies. When a company chooses to expand its
operations it should consider the government regulations in that specific industry
or country and their associated risks.
◎ Examples of political factors include:
◎ Barriers to international trade
◎ Changes in government regulation
◎ Tax policy
◎ Employment laws
◎ Country-specific political risk
 
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 Economic Factors
◎ Economic factors are things that influence the macro economy, such as:
◎ Interest rates
◎ Foreign exchange rates
◎ Inflation
◎ Gross Domestic Product (GDP) growth rates
◎ Each of these factors can have various impacts on businesses.
◎ E.G. interest rates affect the cost of capital and a company’s ability to raise
funds or invest in new assets.
◎ Low exchange rates reduce threats from foreign competitors and create
overseas opportunities. When inflation happens, it destabilizes the economy
and makes the future less predictable for companies.
◎  
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 Socio-Demographic (Social) Factors
◎ Socio-demographic factors is short for social and demographic factors, which concern
population demographics and the characteristics of a company’s target customers.
◎ Examples of social-demographic factors include:
◎ Population growth
◎ Education level
◎ Health consciousness and trends
◎ Nature and the environment
◎ Age cohort changes
◎ Changing social values can impact the business of an entire industry because they shift
consumer preferences and demand for products/services. For example, if a majority of the
population perceives smoking as harmful to physical health, then demand for cigarettes and
tobacco could significantly decline and, thus, impact the profitability of those businesses.

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 Technological Factors
◎ Technological factors have become increasingly important for many businesses in recent
years due to the prevalence of information technology and mobile devices.
◎ Some examples of technological factors include:
◎ Research & development (R&D) investment
◎ Scientific advances
◎ emerging technologies
◎ Diffusion of technologies
◎ These technological factors affect the height of the barrier to entry of an industry and
reshape the industry structure.
◎ Broad Factors Analysis helps to arrive at an understanding of the net
potential impact of these factors on a business, and the overall
attractiveness, opportunities, and threats that exist for the company in a
given market.
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 3. SWOT Analysis
◎ A SWOT Analysis is one of the most commonly used tools to assess the internal
and external environments of a company.

◎ SWOT analysis can be done for a product, place, industry, or person.

◎ A SWOT analysis is a simple and effective framework for identifying strengths,

weaknesses, opportunities, and threats that a company faces.

◎ It is important to leverage strengths, minimize threats, and to take advantage of

available opportunities.
◎ SWOT analysis bridges gap between what the company has accomplished to date
(SW) and the strategic alternatives that are available (OT).

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 Internal Factors
◎ Internal factors are the strengths and weaknesses of the company and are
current or backward-looking.
◎ Strengths are the characteristics that give the business its competitive advantage,
while weaknesses are characteristics that a company needs to overcome in order
to improve its performance.
◎ Examples of internal factors include:
◎ Company culture, Company image, Operational efficiency, Operational capacity,
Brand awareness
◎ Market share
◎ Financial resources
◎ Key staff
◎ Organizational structure
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 External Factors
◎ External factors are the opportunities and threats to the company and are
forward-looking.
◎ Opportunities are elements that the company sees in the external environment
that it could pursue in the future to generate value. Threats are elements in the
external environment that could prevent the company from achieving its goal or
its mission or creating value.
◎ Changes in the external environment may be due to:
◎ Societal changes, Customers, Competitors, Economic environment,
Government regulations
◎ Suppliers
◎ Partners
◎ Market trends
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 Strengths:
◎ Consider strengths from an internal and consumer perspective.
◎ What advantages does your company have?
◎ What unique resources that you have that others do not?
◎ What is your company’s Unique Selling Proposition?
◎ What positive consumer perception does your company have?
◎ What low-cost resources do you have access to that others do not?

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 Weaknesses:
◎ Consider weaknesses from an internal and consumer
perspective.
◎ What does your company not do well?
◎ What weaknesses do consumers see in your company?
◎ What factors contribute to a weaker brand image?

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 Opportunities:
◎ Consider opportunities from an external perspective.
◎ What good opportunities are available in the marketplace?
◎ What are some trends that your company can capitalize on?
◎ Are there any changes in technology or markets that your company can
take advantage of?
◎ Are there any changes in lifestyle, social patterns, etc., that your company
can take advantage of?

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 Threats:
◎ Consider threats from an external perspective.
◎ What obstacles does your company face?
◎ What are your competitors doing better than you?
◎ Is a change in technology threatening the position of your company?
◎ What threats do your weaknesses put you at risk of?
◎ Do changes in lifestyle, social patterns, etc., pose a threat to your
company?

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https://www.ksestocks.com/ListedSectors

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