Macroeconomic and Industry Analysis Chapter 12 Macroeconomic and Industry Analysis

Outline Valuation approach Global economy The domestic economy Demand and supply shock Federal government policy Business cycles: the Macro Cycle Industry analysis and industry life-cycle; the Micro Cycle Competitive positioning

Framework of Analysis Fundamental Analysis Approach to Fundamental Analysis Domestic and global economic analysis Industry analysis Company analysis Top-down approach

An alternative approach Stock price is the present value of all future cash flows it generates to its holder Factors influencing dividends: top down Factors influencing discount rates Risk free rate Inflation Risk aversion degree Interest rate also affects company earnings power

Global Economic Considerations Foreign Demand Foreign demand critical for US recovery from 2008 financial crisis Exchange rate risk Cheap $ helps US exports, while appreciation of $ hurts Sales and Earnings Stock returns

Key Domestic Economic Variables Gross domestic product Unemployment rates Interest rates & inflation Impact on fix-income assets Impact on stocks Budget deficit Government spending-Revenue Sentiment Consumer confidence Business

Demand Shocks Demand shock - an event that affects demand for goods and services in the economy Who demand goods? Tax rate cut Increases in government spending Money supply Foreign exports demand

Supply Shocks Supply shock - an event that influences production capacity or production costs Basic commodity price changes (oil price) Whether to agriculture

Federal Government Policy Fiscal Policy – government spending and taxing actions Direct policy Slowly implemented

Federal Government Policy (cont.) Monetary Policy - manipulation of the money supply to influence economic activity Tools of monetary policy Open market operations Discount rate Reserve requirements

Business Cycles-Macro Cycle Business cycle is the recurring pattern or recession and recovery

Cyclical Indicators: Leading Leading Indicators - tend to rise and fall in advance of the economy Examples Stock Prices: reflect anticipation of future Money supply, New orders for goods: impact future

Cyclical Indicators: Coincident Coincident Indicators - indicators that tend to change directly with the economy Examples Industrial production Manufacturing and trade sales

Cyclical Indicators: Lagging Lagging Indicators - indicators that tend to follow the lag economic performance Examples Average duration of unemployment

Industry Analysis-sensitivity to business cycle Sensitivity to business cycles Factors affecting sensitivity of earnings to business cycles Sensitivity of sales of the firm’s product to the business cycles Defensive: Necessities (Grocery, Drugs, Medical), small/cheap items (Movies, DVD, tobacco) Sensitive/Cyclical : big items and luxury ( house, car, jewels, premium brands) Operating leverage (Fixed costs are fixed) Financial leverage (interest payments are fixed)

Industry Analysis: Industry Life Cycles(micro cycle) Stage Sales Growth Start-up Rapid & Increasing Consolidation Stable Maturity Slowing Relative Decline Minimal or Negative

Industry analysis: Competitive environment Porter’s five forces Threat of entry Rivalry between existing competitors Pressure from substitute products Bargaining power of buyers Bargaining power of suppliers