Macroeconomics and Industry Analysis, BKM Ch 17 Zvi Wiener tel: 02-588-3049 mswiener@mscc.huji.ac.il Fall-02 http://pluto.mscc.huji.ac.il/~mswiener/zvi.html

Framework of Analysis Fundamental Analysis Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Framework of Analysis Fundamental Analysis Approach to Fundamental Analysis: Domestic and global economic analysis Industry analysis Company analysis Why use the top-down approach? Zvi Wiener BKM Ch 17

Global Economic Considerations Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Global Economic Considerations Performance in countries and regions is highly variable. Political risk Exchange rate risk Sales Profits Stock returns Zvi Wiener BKM Ch 17

Key Economic Variables Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Key Economic Variables Gross domestic product Unemployment rates Interest rates & inflation International measures Consumer sentiment Zvi Wiener BKM Ch 17

Federal Government Policy Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Federal Government Policy Fiscal Policy - government spending and taxing actions. Direct policy Slowly implemented Zvi Wiener BKM Ch 17

Federal Government Policy (cont’d) Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Federal Government Policy (cont’d) Monetary Policy - manipulation of the money supply to influence economic activity. Initial & feedback effects Tools of monetary policy Open market operations Discount rate Reserve requirements Zvi Wiener BKM Ch 17

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Demand Shocks Demand shock - an event that affects demand for goods and services in the economy. Tax rate cut Increases in government spending Zvi Wiener BKM Ch 17

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Supply Shocks Supply shock - an event that influences production capacity or production costs. Commodity price changes Educational level of economic participants Zvi Wiener BKM Ch 17

Business Cycles Business Cycle Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Business Cycles Business Cycle Peak Trough Industry relationship to business cycles Cyclical Defensive Zvi Wiener BKM Ch 17

NBER Cyclical Indicators: Leading Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. NBER Cyclical Indicators: Leading Leading Indicators - tend to rise and fall in advance of the economy. Examples: Avg. weekly hours of production workers Stock Prices Zvi Wiener BKM Ch 17

NBER Cyclical Indicators: Coincident Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. NBER Cyclical Indicators: Coincident Coincident Indicators - indicators that tend to change directly with the economy. Examples: Industrial production Manufacturing and trade sales Zvi Wiener BKM Ch 17

NBER Cyclical Indicators: Lagging Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. NBER Cyclical Indicators: Lagging Lagging Indicators - indicators that tend to follow the lag economic performance. Examples: Ratio of trade inventories to sales Ratio of consumer installment credit outstanding to personal income Zvi Wiener BKM Ch 17

Industry Analysis Sensitivity to business cycles Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Industry Analysis Sensitivity to business cycles Factors affecting sensitivity of earnings to business cycles: Sensitivity of sales of the firm’s product to the business cycles Operating leverage Financial leverage Industry life cycles Zvi Wiener BKM Ch 17

Industry Life Cycles Stage Sales Growth Start-up Rapid & Increasing Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Industry Life Cycles Stage Sales Growth Start-up Rapid & Increasing Consolidation Stable Maturity Slowing Relative Decline Minimal or Negative Zvi Wiener BKM Ch 17

Home Assignment Required: • Read chapter 17 in BKM • problem 18 (5th ed) (see next slide). • closely follow financial news! Zvi Wiener BKM Ch 17

problem 18 (5th ed) Your business plan for your proposed start-up firm envisions first-year revenues of $120,000 fixed costs of $30,000 and variable costs equal to one-third of revenue. A. What are expected profits based on these expectation? B. What is the degree of operating leverage based on the estimate of fixed costs and expected profits? C. If sales are 10% below expectation, what will be the decrease in profits? D. Show that the percentage decrease in profits equals DOL times the 10% drop in sales. E. Based on the DOL, what is the largest percentage shortfall in sales relative to original expectations that the firm can sustain before profits turn negative? What are break-even sales at this point? F. Confirm that your answer to (E) is correct by calculating profits at the brake-even level of sales. Zvi Wiener BKM Ch 17