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Chapter 12
Macroeconomic
and Industry
Analysis
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
12.1 The Global Economy
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Framework of Analysis
• Fundamental Analysis
– Analysis of the determinants of firm value,
specifically attempting to forecast the
earnings and dividends of a firm.
– Top down approach:
 The Global Economy


Analyze economy
Analyze industry
Analyze firm
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Framework of Analysis
• Approach to Fundamental Analysis
– Domestic and global economic analysis
• Performance in countries and regions is highly
variable
• Politics affects the economy
• Foreign exchange rates affect U.S. firms and their
competitors
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Framework of Analysis
• Approach to Fundamental Analysis
– Industry analysis
• Critical to understand the competitiveness of the
industry
– Company analysis
• Detailed strategic and financial analysis of the firm
• Why use the top-down approach?
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12.2 The Domestic
Macroeconomy
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Key Economic Variables
• Gross domestic product
– The market value of gods and services produced
domestically in a given time period
• Unemployment rate
– The ratio of number of people classified as
unemployed to the total labor force
• Inflation
– The rate of change in the general price level as
measured by some price index:
• Consumer Price Index, Producer Price Index, GDP
Deflator
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Key Economic Variables
• Interest rates
– Major impact on security prices (stocks and
bonds) and the level of economic growth
• Budget Deficits
– Budget deficits can crowd out private
investment, private investment generates
more growth than public sector investment.
– Alternative to crowding out is overreliance on
foreign borrowing.
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Key Economic Variables
• Consumer sentiment
– Consumers’ optimism or pessimism
concerning the economy and job prospects.
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12.3 Interest Rates
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Factors Determining the Level of
Interest Rates
1. Supply of funds from savers
2. Demand for funds from businesses
3. Government’s net supply and demand for funds
– Fiscal policy
– Monetary policy
4. Expected rate of inflation
– Interest rates contain a premium for expected
inflation
– The Federal Reserve typically raises interest
rates proactively when inflation is expected to
increase
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Determination of the
Equilibrium Real Rate of Interest
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12.4 Demand and Supply
Shocks
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Demand Shocks
• Demand Shock
– An event that affects the demand for goods
and services, some examples include:
•
•
•
•
Change in tax rates
Change in the money supply
Change in government spending
Change in foreign export demand
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Supply Shocks
• An event that influences production capacity
and input costs, including labor costs;
examples:
• Changes in the price or availability of imported oil
• Freezes, Floods, Droughts
• Changes in wage rates
• Negative supply shocks result in reduced
output, slower economic growth.
• demand > supply, which is inflationary.
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Implications for investments
Choose industries that will be helped by your
expected economic scenario and avoid those that
will be hurt.
– Choose consumer cyclicals if the economy is
projected to do well, but not if the economy will
weaken,
– May choose consumer staples and necessities such
as utilities if the economy is not expected to do well.
– To earn abnormal returns you must have better
information (unlikely) or better analysis than the
competition.
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12.5 Federal Government
Policy
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Fiscal Policy
• Government spending and taxing actions to
stabilize or spur growth in the economy
– Most direct policy method in terms of its effect on
the economy (Keynesian policy)
– Often implemented too slowly due to political
process
– Poor means to fine tune an economy, can be
inflationary
– May be necessary when monetary policy is
ineffective such as in the Financial Crisis of 2008
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Monetary Policy
• Manipulation of the money supply to
influence economic activity by influencing
the demand for goods and services to be
produced and consumed
– Initial & long run effects
– Potentially long lags
– Changes incentives to purchase and invest,
but may not lead to desired effect on demand
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Supply-Side Policies
• Supply-siders focus on incentives and
marginal tax rates
• Lowering tax rates tends to
– encourage more investment
– Improve incentives to work
– Income inequality may also rise
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Supply-Side Policies
• Income inequality may also rise
– Those with better ideas, education,
opportunities, work ethic, providence, etc.
will do better, others may not.
– If the majority are better off, but some much
more so than others does this indicate that
we should not use supply side policies?
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Supply-Side Policies
• Income inequality may also rise
– Those with better ideas, education,
opportunities, work ethic, providence, etc.
will do better, others may not.
– If the majority are better off, but some much
more so than others does this indicate that
we should not use supply side policies?
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12.6 Business Cycles
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The Business Cycle
• Recurring patterns of recession and recovery
– Peak
– Trough
• Industry relationship to business cycles
– Cyclical industries
• Industries with above average sensitivity to the
state of the economy
– Defensive
• Industries with below average sensitivity to the
state of the economy
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Economic Indicators
• Leading Indicators - tend to rise and fall in
advance of the economy
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Economic Indicators (cont)
• Coincident Indicators - indicators that tend to
change at the same time as the economy
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Economic Indicators (cont)
• Lagging Indicators - indicators that tend to
follow or lag economic performance
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Other Indicators
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Economic Calendar at Yahoo!
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12.7 Industry Analysis
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Industry Analysis
• Performance can vary widely across industries
– It is difficult to find a good stock in a poor industry
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Industry Stock Price Performance, 2008
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ROE of Application Software Firms, 2008
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Sensitivity to Business Cycle
• Factors affecting sensitivity of earnings to
business cycles
– Sensitivity of sales of the firm’s product to the
business cycles
– Fixed costs and leverage
• Fixed costs are costs that do not vary with the level
of production.
• Fixed costs contribute to higher profitability when
sales are high, but will result in lower profitability
when sales are lower.
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Sensitivity to Business Cycle
– Operating leverage
• Proportion of fixed operating costs as a percent of
total costs
• Greater operating leverage results in greater
swings in profits over the business cycle
– Airlines, automobiles
– Financial leverage
• Proportion of fixed financing costs as a percent of
total costs
• Greater financial leverage results in greater swings
in profits over the business cycle
– Airlines, banks, investment banks
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Industry Cyclicality
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A Stylized Depiction
of the Business Cycle
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Sector Rotation
Selecting Industries in line with the stage
of the business cycle:
• Peak
natural resource firms
• Contraction defensive firms
equipment, transportation and
• Trough
construction firms
• Expanding
cyclical industries
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Sector Rotation Illustrated
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Industry Life Cycles
Stage
Start-up
Consolidation
Maturity
Relative Decline
Sales Growth
Rapid & Increasing
Stable
Slowing
Minimal or Negative
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The Industry Life Cycle
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Industry Structure and
Performance (Porter Model)
Determinants of Industry
Competition and Profitability
• Threat of Entry
– New entrants reduce profitability
– Barriers to entry preserve profitability
•
•
•
•
•
•
Large scale required to be profitable (autos)
Secure distribution channels
Brand loyalty, unique differentiated product
Proprietary production technology
Intellectual property protections
Learning curve effects
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Determinants of Industry
Competition and Profitability
• Rivalry between existing competitors
– Equal competitors reduce profitability
– Slow industry growth,
– High fixed costs,
– Scale economies,
Pressure to
cut prices
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Determinants of Industry
Competition and Profitability
• Pressure from substitute products
– Substitutes limit profitability (propane, natural gas)
• Bargaining power of buyers
– A buyer that purchases a large percent of an
industry’s output can limit the selling industry’s
profitability (auto parts suppliers)
• Bargaining power of suppliers
– A supplier that controls a key input can limit the
buying industry’s profitability (labor unions)
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