An analysis of the performance, prospects and problems of the industry of interest is known as industry analysis in fundamental analysis. The economic analysis indicates the direction of the economy and the stock market. Industry analysis in fundamental analysis is required because the return and risk levels of industries differ.
The risk factors related to the automobile industry are diverged from those related to the information technology industry. Consumer spending has a greater concussion on the automobile industry than on the IT industry. The performance of an industry echo the performance of the companies it consists of.
An industry is a group of firms that have a related technological structure of production and -produce similar products. For the convenience of investors, a brand classification of industries is given in financial details and magazines. Companies are distinctly classified to show clear pictures of their manufacturing processes and products.
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Factors of Industry Analysis in fundamental analysis
given below explanation is the factors of industry analysis in fundamental analysis…..
Nature and type of industry;
Depending upon an industry’s response to business cycles, it can be differentiate as a cyclical industry or defensive industry as explained below:
Cyclical Industries:
industries that are more responsive or sensitive to business cycles are termed cyclical industries. The performance of cyclical industries differ according to business cycles. During expansion or boom periods these industries outperform other industries.
Examples of cyclical industries are consumer durables, automobiles, capital goods, construction, etc. because the purchase of these goods can be deferred during a recession, sales are particularly sensitive to economic conditions. Therefore, sales of these industries decline faster than other industries and thus they bear the brunt of a slowdown.
Defensive industries:
in contrast to cyclical industries, defensive industries’ growth rates are less sensitive to the business cycle. These are the industries producing goods and services, sales of which are little bit sensitive to the state of the economy.
Examples of defensive industries include pharmaceuticals, food products, education, public utilities, etc. these industries outperform other industries when a recession starts in an economy.
Whether the industry is cyclical or defensive, it is important to analyze certain features of the industry. These features are crucial for proper assessment and forecast related to earnings and dividends at the company level.
Industry Life cycle:
The industry life cycle theory is generally attributed to Julius Grodinsky, a Wharton School of Business professor. The life cycle of the industry is differentiate into four well-defined stages as given below:
Pioneering stage
Rapid growth stage
Maturity and stabilization stage
Declining stage
Pioneering Stage:
in this stage, the prospective demand for the product is bright and the technology of the product is low. The demand for the product inspire many producers to produce that particular product.
There is severe competition and only the competent companies survive this stage. The producers try to develop the brand name, the severe competition often leads to the change of position of the firms in terms of market shares and profits.
In this situation, it is difficult to choose companies for investment because the survival rate is unknown.
Rapid Growth Stage:
This stage begins with the appearance of surviving firms from the pioneering stage. The companies that have withstood the competition steadily improve their market shares and financial performance.
The technology used in production progress resulting in low cost of production and good quality products. The companies have stable growth rates in this stage and they declare a dividend to their shareholders.
It is desirable to invest in the shares of these companies. The pharmaceutical industry industries have improved their technology and the top companies in this sector are giving dividends to their shareholders.
The power and telecommunication industries can also be cited as examples of industries in this expansion stage. At this stage, the growth rate is more than the industry’s average growth rate.
Maturity and Stabilizing Stage:
in this stabilization stage, the growth rate tends to moderate and the rate of growth more or less equals the industrial growth rate or the gross domestic product growth rate.
Symptoms of obsolescence may appear in technology. To keep going technology innovations in the production process and products have to be introduced. Investors must closely auditor the events that take place in the maturity stage of the industry.
Declining Stage:
in this stage, demand for a particular product and the earnings of the companies in the industry decline. Nowadays, very few costomers demand black and white television sets.
Innovations and changes in consumer preferences lead to this stage. The specific feature of the declining stage is that even in a boom; the growth rate of the industry is low and declines at a higher rate during a recession.
It is better to avoid investing in the shares of the low-growth industry even during the boom. Investment in the shares of these types of companies leads to loss of capital.
Other Factors OF INDUSTRY ANALYSIS IN FUNDAMENTAL ANALYSIS
Apart from industry life cycle analysis, an investor must also analyze other factors of industry analysis in fundamental analysis such as those given below:
Growth of the industry
Cost structure and profitability
Nature of the product
Nature of the competition
Government policy
Labour
Research and Development
Growth of the industry:
The historical performance of the industry in circumstances of growth and profitability should be analyzed. Industry-wise growth is published annually by the Centre for Monitoring Indian Economy. the past variability in return and growth in reaction to macroeconomic factors grant an insight into the future.
Even though history may not be repeated exactly, by looking into the past growth of the industry, an analyst can’t predict the future. The information technology industry has witnessed amazing growth in the past as have the scrip prices of the IT Industry.
Cost structure and profitability:
The cost structure which is the proportion of fixed and variable costs affects the cost of production and profitability of the firm. In the case of the oil and natural gas trade, and the iron and steel industry.
The fixed cost portion is high and the greatest period is also lengthy. The higher the fixed cost component the greater the sales volume required to reach the firm’s break-even point. Once the break-even point is reached and production is on track, profitability can be boost by utilizing the capacity to full.
Once the maximum capacity is achieved capital must again be invested in the fixed equipment. Hence, the lower the fixed costs, the easier it is to adjust to changing demand and reach the break-even point.
Nature of the Product
The product produced by industries is demanded by consumers and other industries. Demand for industrial products like pig iron, iron sheets, and coil, for example, comes from the construction industry.
Likewise, the textile machine tools industry produces tools for the textile industry and the intigrated demand depends upon the health of the textile industry.
An investor must analyze the condition of the feederlaborer industry as well as the end user industry to assess the demand for industrial goods. à in the case of the consumer goods industry, a change in consumer preference, technology innovations, and substitute products affect demand.
Nature of Competition:
The nature of competition is an essential factor that regulate the demand for a particular product, its profitability, and the price of the scrip concerned. The supply may derive from indigenous producers and multinationals.
Take detergents produced by the indigenous manufacturer and distributed locally at competitive prices. This poses a peril to the products made by a big company. Multinationals are also entering the field with sophisticated production processes and better-quality products.
The company’s ability to withstand the competition locally and from multinationals affects its earnings. If too many firms are present in the organized sector, the competition will be served.
It will lead to a decrease in the price of the product. The investor, before investing in the scrip of the company, should analyze the market share of the particular company’s product and compare it with the top five companies.
Government Policy:
Government policies affect the very nerve of the industry and the effects diverge from industry to industry. Tax subsidies and tax holidays are providing for export-oriented products.
The government regulates the size of the production and the pricing of certain products. Control and decontrol of sugar prices affect the drsirability of the sugar industry. In some cases, entry barriers are placed by the government.
In the airline sector, private corporations are permitted to operate only domestic flights. When selecting an industry-government policy regarding particular industries should be carefully evaluated. liberalization and delicensing have brought an immense threat to existing domestic industries in several sectors.
Labour
The analysis of the labor scenario in a particular industry is of great importance. The number of trade unions and their operating mode has an impact on labor productivity and the modernization of the industry.
The textile industry is also known for its militant trade unions. If trade unions are strong and strike occur frequently, it will lead to a fall in production. In an industry of high fixed costs, the blockage of production may lead to losses.
When trade unions oppose the introduction of automation, the product market the company may stand to lose owing to the high cost of production. An unhealthy labor relationship also leads to the loss of customers’ goodwill.
Skilled labor is needed for certain industries. In the case of the Indian labor market, even in IT and other industries, skilled and well-qualified labor is available at a cheaper rate. This is one of the many reasons engaing multinationals to set up companies in India.
Research and Development:
For any industry to survive competition in the national and international market, the product and production processes have to be technically competent. This depends on the Research & Development in the particular company or industry.
Economies of scale and new markets can be seized only through R&D. The percentage of expenditure on R&D should be studied diligently before investing.
Pollution Standards:
Pollution standards are very tough and strict in the industrial sector. This is particularly so in the leather, chemical, and pharmaceutical industries that have dominant industrial effluents.
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