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Investments: Analysis and
Behavior
Chapter 9 - Business Environment
Learning Objectives
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Know the major forces driving economic growth
Define the economic environment
Identify industries /sectors
Learn the impact of regulation
Analyze the level of corporate governance in a firm
Current Events Article
Title: Consumer Sentiment Dips to Lowest
Since November
Author: Caroline Valetkevitch
Source: Reuters
Link:
http://www.reuters.com/article/idUSTRE69
S2LA20101029?loomia_ow=t0:s0:a49:g43:
r3:c0.200000:b38946892:z0
3
Fundamental Analysis
Top-down approach
– Economy aspects
• Industry aspects
 Firm specific
» Accounting - Recording, reporting and analysis of
financial transactions of a business
» Valuation: value (bargains) vs. growth (without
regard for money) firms
Dimensions of the Economy
 As the economy goes, so goes the businesses and
their stock(s)…
 Macroeconomic Environment
– Aggregate Economic Activity
• Gross Domestic Product ($14,730.2 Billion)
 The total value of all goods and services produced by all people within the
boundaries of a country during a one-year period
• Interest rates (0.25 percent)
• Consumer spending and consumer income
• Employment (9.2% unemployment rate)
 Microeconomic Environment
– Industry, Firm, Plant, or Product Level
• Industry specific regulation
• Material prices
Forces Driving the Economy
Figure 9.1 U.S. 2007 Population Distribution
25,000
1) Demographics
– Baby boom
generation
• Born 1946
through 1964
Population in Age Group (in thousands )
Baby Boom Generation
20,000
15,000
10,000
5,000
0
<5
5 to 9
10 to 14 15 to 19 20 to 24 25 to 29 30 to 34 35 to 39 40 to 44 45 to 49 50 to 54 55 to 59 60 to 64 65 to 69 70 to 74 75 to 79 80 to 84
Significant impact on
society:
Age (in years)
Figure 9.2 A Changing Age Distribution
12%
1950
• spending
• working/retirement
• housing
Percent of Population
• saving
2030
10%
8%
6%
4%
2%
0%
<5
5 to 9
10 to 14 15 to 19 20 to 24 25 to 29 30 to 34 35 to 39 40 to 44 45 to 49 50 to 54 55 to 59 60 to 64 65 to 69 70 to 74
Age Group (in years)
>75
> 84
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.
Figure 9.3 Actual and Trend in Labor Productivity
150
Index, 1992 = 100
Trend = 2.23% per year
130
110
Trend = 1.28% per year
90
Actual
70
Trend = 2.51% per year
Source: US Bureau of Labor Statistics
2005
2000
1995
1990
1985
1980
1975
1970
1965
1960
50
3) International Trade
– Imports
– Exports
Balance of trade
• The total value of a nation’s exports minus the total value
of its imports over some period of time
Trade deficit
• A negative (unfavorable) balance of trade—imports
exceed exports in value
Balance of payments
• The total flow of money into a country minus the total
flow of money out of that country over a period of time
U.S. International Trade in
Goods
Source: U.S. Department of Commerce, International Trade Administration, U.S. Bureau of Economic Analysis,
http://bea.gov/international/bp_web/simple.cfm?anon=78260&table_id=1&area_id=3, accessed September 18, 2008.
Value of U.S. Merchandise
Exports and Imports
Source: U.S. Department of Commerce, International Trade Administration, http://www.census.gov/foreign-trade/statistics/
highlights/top/top0712.html, accessed September 22, 2008.
Business Cycles
 Pattern of economic recession and expansion
– Periods of economic expansion are followed by periods
of contractions
 Recession is a sustained period of generally
declining economic activity (GDP)
– Higher unemployment
– Restricted credit
– Reduced output
 Depression
– Devastating recession
Economic Indicators
 Inflation rate
– An economic statistic that tracks the increase in prices of goods and
services over a period of time; usually calculated on a monthly or annual
basis
 National income
– The total income earned by various segments of the population, including
employees, self-employed individuals, corporations, and other type of
income
 New housing starts
– The total number of new homes started during a specific time period.
 Unemployment rate
– The percentage of a nation’s labor force unemployed at any time
Competitive Environment
 Industry’s market structure
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–
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Number and size of competitors
Conditions of entry and exit
Monopoly
Oligopoly
 Competitive advantage
– Better
– Cheaper
– Faster
http://www.forbes.com/lists/2009/18/global-09_The-Global-2000_Sales.html
Michael Porter’s Five Forces
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Rivalry among existing competitors
Threat of new entrants
Pressure from substitute products
Bargaining power of customers
Bargaining power of suppliers
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
Antitrust Policy
 Monopoly
– A market (or industry) with only one seller
 Government promotes competition
– Reviews mergers for impact on competition
Corporate Governance
 Principal-agent problem
– Separation of ownership and control
• Stockholders own the firm with little control
• Managers control the firm with little ownership
 Why should the managers (agents) care about stockholders?
 Corporate governance is the monitoring devices and incentives
in place to protect stockholders.
Executive Compensation
 Aligning managerial incentives
– Salary
• Fixed amount
– Bonus
• Additional pay for meeting various accounting targets
– Incentive pay
• Options, stock, restricted stock
– Benefits and Perks
http://money.cnn.com/2009/08/14/news/companies/highest_paid_ceos
Monitoring Executives
 Board of Directors
 Active shareholders
– Institutional investors
 Auditors
 Analysts
 Investment banks
 Credit rating agencies
 SEC
Ownership Structure
 Corporate ownership
– Stock
• The shares of ownership of a corporation
– Stockholder
• A person who owns a corporation’s stock
– Closed corporation
• A corporation whose stock is owned by relatively few people and is not sold to
the general public
– Open corporation
• A corporation whose stock is bought and sold on security exchanges and can be
purchased by any individual
 Inside equity
– Shares held by top management.
 Does high inside equity mean managers:
– Are aligned with shareholders?
– Are entrenched?
Hierarchy of Corporate Structure
 Stockholders exercise a great deal of influence
through their right to elect the board of directors
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