INTRODUCTION TO INDUSTRY AND
COMPANY ANALYSIS
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INTRODUCTION
 Industry analysis is the analysis of a specific
branch of manufacturing, service, or trade.
 Understanding the industry in which a company
operates provides an essential framework for the
analysis of the individual company—that is,
company analysis.
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USES OF INDUSTRY ANALYSIS
 Understanding a company’s business and business
environment.
 Identifying active equity investment opportunities.
 Portfolio performance attribution.
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APPROACHES TO IDENTIFYING SIMILAR
COMPANIES
 Industry classification attempts to place companies
into groups on the basis of commonalities.
 Three major approaches to industry classification:
 Products and/or services supplied;
 Business-cycle sensitivities; and
 Statistical similarities.
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PRODUCTS AND/OR SERVICES SUPPLIED
 Modern classification schemes are most commonly
based on grouping companies by similar products
and/or services.
 An industry is defined as a group of companies
offering similar products and/or services.
 Or that are close substitutes for one another.
 Industry classification schemes typically provide
multiple levels of aggregation. The term sector is
often used to refer to a group of related industries.
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PRODUCTS AND/OR SERVICES SUPPLIED
 These classification schemes typically place a
company in an industry on the basis of a
determination of its principal business activity.
 A company’s principal business activity is the
source from which the company derives a majority
of its revenues and/or earnings.
 Examples of classification systems based on
products and/or services include the commercial
classification systems, namely, the Global Industry
Classification Standard (GICS), Russell Global
Sectors (RG S), and Industry Classification
Benchmark. 6

BUSINESS-CYCLE SENSITIVITIES
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 Companies are sometimes grouped on the basis of
their relative sensitivity to the business cycle.
 This method often results in two broad groupings of
companies—cyclical and non-cyclical.
 A cyclical company is one whose profits are
strongly correlated with the strength of the overall
economy.
 A non-cyclical company is one whose
performance is largely independent of the business
cycle. Non-cyclical companies produce goods or
services for which demand remains relatively stable
throughout the business cycle.

DESCRIPTIONS RELATED TO THE
CYCLICAL/NONCYCLICAL DISTINCTION
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 Non-cyclical industries have sometimes been
sorted into defensive (or stable) versus growth.
 Defensive industries and companies are those
whose revenues and profits are least affected by
fluctuations in overall economic activity.
 Growth industries would include industries with
specific demand dynamics that are so strong that
they override the significance of broad economic or
other external factors and generate growth
regardless of overall economic conditions, although
their rates of growth may slow during an economic
downturn.

STATISTICAL SIMILARITIES
 Statistical approaches to grouping companies are
typically based on the correlations of past
securities’ returns.
 Using the technique known as cluster analysis,
companies are separated (on the basis of historical
correlations of stock returns) into groups in which
correlations are relatively high but between which
correlations are relatively low.
 Statistical approaches rely on historical data, but
analysts have no guarantee that past correlation
values will continue in the future.
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INDUSTRY CLASSIFICATION SYSTEMS
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 Commercial Industry Classification Systems
 Global Industry Classification Standard
 Russell Global Sectors
 Industry Classification Benchmark

DESCRIPTION OF REPRESENTATIVE SECTORS
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 Basic Materials and Processing
 Consumer Discretionary
 Consumer Staples
 Energy
 Financial Services
 Health Care
 Industrial/Producer Durables
 Technology
 Telecommunications
 Utilities

GOVERNMENTAL INDUSTRY CLASSIFICATION
SYSTEMS
 A common goal of each government classification
system is to facilitate the comparison of data—both
over time and among countries that use the same
system.
 International Standard Industrial Classification of All
Economic Activities
 Statistical Classification of Economic Activities in the
European Community
 Australian and New Zealand Standard Industrial
Classification
 North American Industry Classification System
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STRENGTHS AND WEAKNESSES OF CURRENT
SYSTEMS
 Unlike commercial classification systems, most government
systems do not disclose information about a specific business
or company, so an analyst cannot know all of the constituents
of a particular category.
 Commercial classification systems are adjusted more
frequently than government classification systems, which may
be updated only every five years.
 Government classification systems generally do not
distinguish between small and large businesses, between for-
profit and not-for-profit organizations, or between public and
private companies.
 Another limitation of current systems is that the narrowest
classification unit assigned to a company generally cannot be
assumed to be its peer group for the purposes of detailed
fundamental comparisons or valuation.
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CONSTRUCTING A PEER GROUP
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 A peer group is a group of companies engaged in
similar business activities whose economics and
valuation are influenced by closely related factors.
 One approach to constructing a peer group is to
start by identifying other companies operating in the
same industry.
 An analyst can then investigate the business
activities of these companies and make
adjustments as necessary to ensure that the
businesses truly are comparable.

STEPS IN CONSTRUCTING A PRELIMINARY LIST OF
PEER COMPANIES
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 Examine commercial classification systems, if
available to the analyst.
 Review the subject company’s annual report.
Companies frequently cite specific competitors.
 Review competitors’ annual reports to identify other
potential comparable companies.
 Review industry trade publications to identify
comparable companies.
 Confirm that each comparable company derives a
significant portion of its revenue and operating profit
from a business activity similar to the primary
business of the subject company.

DESCRIBING AND ANALYZING AN INDUSTRY
 In their work, analysts study statistical relationships
between industry trends and a range of economic
and business variables.
 Analysts attempt to develop practical, reliable
industry forecasts by using various approaches to
forecasting.
 Investment managers and analysts also examine
industry performance
 in relation to other industries to identify industries with
superior/inferior returns and
 over time to determine the degree of consistency,
stability, and risk in the returns in the industry over time.
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DESCRIBING AND ANALYZING AN INDUSTRY
 Often, analysts examine strategic groups (groups
sharing distinct business models or catering to
specific market segments in an industry) almost as
separate industries within industries.
 Analysts often consider and classify industries
according to industry life-cycle stage.
 The experience curve shows direct cost per unit of
good or service produced or delivered as a typically
declining function of cumulative output.
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DESCRIBING AND ANALYZING AN INDUSTRY
 The experience curve declines
 because as the utilization of capital equipment
increases, fixed costs (administration, overhead,
advertising, etc.) are spread over a larger number of
units of production,
 because of improvements in labor efficiency and
management of facilities, and
 because of advances in production methods and
product design.
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PRINCIPLES OF STRATEGIC ANALYSIS
 Analysis of the competitive environment with an
emphasis on the implications of the environment for
corporate strategy is known as strategic analysis.
 When analyzing an industry, the analyst must recognize
that the economic fundamentals can vary markedly
among industries.
 Differing competitive environments are often tied to the
structural attributes of an industry, which is one reason
industry analysis is a vital complement to company
analysis.
 As analysts examine the competitive structure of an
industry, they should always be thinking about what
attributes could change in the future. 20

PRINCIPLES OF STRATEGIC ANALYSIS
 Porter (2008) identified the following five
determinants of the intensity of competition in an
industry:
 threat of entry
 power of suppliers
 power of buyers
 threat of substitutes
 rivalry among existing competitors
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THREAT OF NEW ENTRANTS AND THE LEVEL
OF COMPETITION IN AN INDUSTRY
 Barriers to Entry
 Industry Concentration
 Industry Capacity
 Market Share Stability
 Industry Life Cycle
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INDUSTRY LIFE CYCLE
 Embryonic
 Growth
 Shakeout
 Mature
 Decline
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USING AN INDUSTRY LIFE-CYCLE MODEL
 New industries tend to be more competitive (with
lots of players entering and exiting) than mature
industries, which often have stable competitive
environments and players that are more interested
in protecting what they have than in gaining lots of
market share.
 However, as industries move from maturity to
decline, competitive pressures may increase again
as industry participants perceive a zero-sum
environment and fight over pieces of an ever-
shrinking pie.
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USING AN INDUSTRY LIFE-CYCLE MODEL
 An important point for the analyst to think about is
whether a company is “acting its age” relative to
where its industry sits in the life cycle.
 Companies in mature industries are likely to be
pursuing replacement demand rather than new
buyers and are probably focused on extending
successful product lines rather than introducing
revolutionary new products.
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LIMITATIONS OF INDUSTRY LIFE-CYCLE
ANALYSIS
 The evolution of an industry does not always follow
a predictable pattern.
 Various external factors may significantly affect the
shape of the pattern, causing some stages to be
longer or shorter than expected and, in certain
cases, causing some stages to be skipped
altogether.
 Technological changes may cause an industry to
experience an abrupt shift from growth to decline,
thus skipping the shakeout and mature stages.
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LIMITATIONS OF INDUSTRY LIFE-CYCLE
ANALYSIS
 Regulatory changes can also have a profound
impact on the structure of an industry.
 Social changes also have the ability to affect the
profile of an industry.
 Demographics also play an important role.
 Thus, life-cycle models tend to be most useful for
analyzing industries during periods of relative
stability.
 Another limiting factor of models is that not all
companies in an industry experience similar
performances.
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PRICE COMPETITION
 A highly useful tool for analyzing an industry is
attempting to think like a customer of the industry.
 Whatever factor most influences customer
purchase decisions is likely to also be the focus of
competitive rivalry in the industry.
 Switching can be expected as a result of a
unilateral price increase in the case of most
industries in the “Weak Pricing Power”.
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ELEMENTS OF A STRATEGIC ANALYSIS FOR
INDUSTRIES
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 Major Companies
 Barriers to
Entry/Success
 Level of Concentration
 Impact of Industry
Capacity
 Industry Stability
 Life Cycle
 Price Competition
 Demographic
Influences
 Government &
Regulatory Influences
 Social Influences
 Technological
Influences
 Growth vs. Defensive
vs. Cyclical

EXTERNAL INFLUENCES ON INDUSTRY
GROWTH, PROFITABILITY, AND RISK
 Macroeconomic Influences
 Technological Influences
 Demographic Influences
 Governmental Influences
 Social Influences
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COMPANY ANALYSIS
 Company analysis includes an analysis of the
company’s financial position, products and/or
services, and competitive strategy (its plans for
responding to the threats and opportunities
presented by the external environment).
 Company analysis takes place after the analyst has
gained an understanding of a company’s external
environment
 the macroeconomic,
 demographic,
 governmental,
 technological, and
 social forces influencing the industry’s competitive
structure.
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COMPANY ANALYSIS
 Porter identifies two chief competitive strategies:
 a low-cost strategy (cost leadership) and
 a product/service differentiation strategy.
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ELEMENTS THAT SHOULD BE COVERED IN A
COMPANY ANALYSIS
 Provide an overview of the company (corporate profile),
including a basic understanding of its businesses,
investment activities, corporate governance, and
perceived strengths and weaknesses;
 Explain relevant industry characteristics;
 Analyze the demand for the company’s products and
services;
 Analyze the supply of products and services, which
includes an analysis of costs;
 Explain the company’s pricing environment; and
 Present and interpret relevant financial ratios, including
comparisons over time and comparisons with
competitors.
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SELF STUDY
 Exhibit 8 A Checklist for Company Analysis
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