Industry analysis

OBJECTIVES

 Explain the phases of the industry life cycle.

 Relate dividend policy to the life cycle.
 Describe the various economic structures of industries.
 Explain the effect that government regulation can have on an industry.
 Describe how to compare the performance of many companies within the same industry.
 Explain the concept of rotational investing in which the investor shifts emphasis among
industries during various phases of the business cycle.

OUTLINE

INDUSTRY LIFE CYCLE

 Industry life cycles vs. product life cycles

 Dividend policy and the life-cycle curve
 Development –stage 1
 Growth- stage 2
 Expansion-stage 3
 Maturity- stage 4
 Decline- stage 5
 Growth in non-growth industries

INDUSTRY STRUCTURE

 Economic structure
 Competitive structure

PHARMACEUTICAL INDUSTRY: AN EXAMPLE

 Life-cycle analysis
 Government regulation
 Research and development
 Product diversity
 Potent and generic drugs
 Demographics and managed care

INDUSTRY GROUPS AND ROTATIONAL INVESTING

INDUSTRY LIFE CYCLES

Industry life cycles are created because of economic growth, competition, availability of resources, and
resultant market saturation by the particular goods and services offered.

Life cycle growth influences many variables considered in he valuation process. The particular phase of
an industry or company determines the growth of earnings, dividends, capital expenditures, and
market demand for products

INDUSTRY LIFE CYCLES VS. PRODUCT LIFE CYCLES

Product-life cycle has four phases:

Development, growth, maturity and decline

Industry or company life cycle has five phases:

Development, growth, expansion, maturity and decline

DIVIDEND POLICY AND LIFE CYCLE CURVE

Dividend payout ratio has an important effect on company growth. The more funds a firm
retains, and thus, the lower dividend payout, the greater the opportunity for growth

The dividend policy followed by management often provides the analysts with management’s
views of the company’s ability to grow and some indication of where the company is on the life cycle
curve

Insert: GRAPH

DEVELOPMENT-STAGE 1

The development stage includes companies that are getting started in business with a new idea,
product, or production technique that makes them unique.

Firms in this stage are usually privately owned and are financed with the owner’s money as well as with
capital from friends, family, and a bank.

GROWTH-STAGE 2

Stage II growth represents an industry or company that has achieved a degree of market acceptance for
its product. At this stage:

 Earnings will be retained for reinvestment and sales and returns on assets will be
growing at an increasing rate.
 Companies become profitable, and in their early stage of growth, they want to
acknowledge to their shareholders that they have achieved dividends.
EXPANSION-STAGE 3

 In stage III, sales expansion and earnings continue but at a decreasing rate.
 As the industry crosses from the growth stage (accelerating growth) to the expansion
stage (decelerating growth), the slope of the line becomes less steep, signaling slower
growth
 Crossover point is important to the analyst who will also be evaluating declining returns
on investment as more competition enters the market and attempts to take away
market share from existing firms.

MATURITY- STAGE 4

Maturity occurs when industry sales grow at a rate equal to the economy as measured by the
long term trend in gross domestic product (GDP). Some analysts like to use the growth rate of standard
and poor’s 500 index for comparison because growth rate of these 500 large companies sets the norm
for mature companies.

Insert: GRAPH

DECLINE-STAGE 5

In unfortunate cases, industries suffer declines in sales if product innovation has not increased
the product base over the years and declining industries may be specific to a country and also to
weakest company in the industry that cannot compete.

Dividend payout ratios of firms in decline sometimes rise to 100 percent or more earnings.

GROWT IN NON GROWTH INDUSTRY

It is also important that growth companies can exist in a mature industry and that not all
companies within industry experience the same growth path in sales, earnings, and dividends. Some
companies are simply better managed, have better people, have more efficient assets, and have put
more money into productive research and development that has created new or improved products.