FIN432 Vicentiu Covrig 1 Business Environment (chapter 9)

FIN432 Vicentiu Covrig 2 Dimensions of the Economy As the economy goes, so goes the businesses and their stock… Macroeconomic Analysis - aggregate economic activity  Gross Domestic Product  Interest rates  Consumer spending, consumer income  employment Microeconomic Environment - industry, firm, plant, or product level  Industry specific regulation  Material prices (aluminum, wheat, oil, etc.)

FIN432 Vicentiu Covrig 3 Purpose of Economic Analysis Understand the impact of recent economic trends on company you need to value Develop a perspective on how future economic trends will affect profitability and risk of subject company: - current stage of the business cycle - economic growth expectations - supply and demand conditions - inflation expectations - investment and credit conditions - political and regulatory events

FIN432 Vicentiu Covrig 4 Forces Driving the Economy 1) Demographics - Baby boom generation  Born 1946 through 1964 Significant impact on society: spending saving working/retirement housing

FIN432 Vicentiu Covrig 5 2) Productivity - The ability to produce more products and services with the same number of people. - When productivity growth is robust, the standard of living increases. - Gains are often made from advances in technology  Computers, Internet, etc.

FIN432 Vicentiu Covrig 6 3) International Trade Imports Exports

FIN432 Vicentiu Covrig 7 Business Cycles Pattern of economic recession and expansion - Periods of economic expansion are followed by periods of contractions  Recession  2 or more concessive quarters of contraction  Higher unemployment  Restricted credit  Reduced output  Depression  Severe recession (no official definition)

FIN432 Vicentiu Covrig 8 Economic Indicators Data series that successfully describe the pattern of projected, current, or past economic activity. - Leading indicators  Money Supply, building permits, manufacturer’s new orders, initial claims for unemployment - Lagging Indicators  Consumer price index, inventories, labor cost - Coincident Indicators  Industrial production, personal income, payrolls

FIN432 Vicentiu Covrig 9 Grouping and Classifying the Economy and Companies Industry Classifications - Categorize companies by the principal activity in which they are engaged. - North American Industry Classification System (NAICS)  US Census Bureau  Two to six digits Code Industry 11Agriculture, Forestry, Fishing, and Hunting 21Mining 22Utilities 23Construction 31Manufacturing 42Wholesale Trade 44-45Retail Trade 48-49Transportation and Warehousing 51Information 52Finance and Insurance 53Real Estate and Rental and Leasing 54Professional, Scientific and Technical Services 55Management of Companies and Enterprises 56Admin. and Support, Waste Mgmt, and Remediation 61Educational Services 62Health Care and Social Assistance 71Arts, Entertainment and Recreation 72Accommodation and Food Services 81Other Services (except Public Administration) 92Public Administration

FIN432 Vicentiu Covrig 10 Competitive Environment Industry’s market structure - Current stage of the industry life cycle - How cyclical it is - Number and size of competitors - Monopoly/Oligopoly - Industry sales and profitability - R&D and technology Competitive advantage

FIN432 Vicentiu Covrig 11 Michael Porter characterizes the competitive environment -- five forces Rivalry among existing competitors Threat of new entrants Pressure from substitute products Bargaining power of customers Bargaining power of suppliers

FIN432 Vicentiu Covrig 12 Measuring Competitiveness Concentration ratios - Measures the percentage market share concentrated in an industry’s top four, eight, twenty, or more firms.  0 to 100  Low numbers indicate vigorous competition: greater than 80% means highly concentrated Herfindahl Hirschmann Index (HHI) - A measure of competitor size inequality  0 to 10,000

FIN432 Vicentiu Covrig 13 Legal Environment Regulation - All sectors of the US economy are regulated to some degree.  OSHA, EPA, etc. - Some industries have high regulation  Banks, utilities, etc. - Costs of regulation are very high

FIN432 Vicentiu Covrig 14