1. Chapter 11 Macroeconomic and Industry Analysis

2. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Fundamental Analysis Approach to Fundamental Analysis Domestic and global economic analysis Industry analysis Company analysis Why use the top-down approach Framework of Analysis

3. McGraw-Hill/Irwin © 2004 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

4. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Key Economic Variables Gross domestic product Unemployment rates Interest rates & inflation Budget Deficits Consumer sentiment

5. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Federal Government Policy Fiscal Policy - government spending and taxing actions Direct policy Slowly implemented

6. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Federal Government Policy (cont.) 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

7. McGraw-Hill/Irwin © 2004 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

8. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Supply shock - an event that influences production capacity or production costs Commodity price changes Educational level of economic participants Supply Shocks

9. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Business Cycles Business Cycle Peak Trough Industry relationship to business cycles Cyclical Defensive

10. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Leading Indicators - tend to rise and fall in advance of the economy Examples Avg. weekly hours of production workers Stock Prices NBER Cyclical Indicators: Leading

11. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Coincident Indicators - indicators that tend to change directly with the economy Examples Industrial production Manufacturing and trade sales NBER Cyclical Indicators: Coincident

12. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. 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 NBER Cyclical Indicators: Lagging

13. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Industry Analysis Sensitivity to business cycles Sector Rotation Industry life cycles

14. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Sensitivity to Business Cycle Factors affecting sensitivity of earnings to business cycles Sensitivity of sales of the firm’s product to the business cycles Operating leverage Financial leverage

15. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Sector Rotation Selecting Industries in line with the stage of the business cycle Peak – natural resource firms Contraction – defensive firms Trough – equipment, transportation and construction firms Expanding – cyclical industries

16. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Industry Life Cycles StageSales Growth Start-upRapid & Increasing ConsolidationStable MaturitySlowing Relative DeclineMinimal or Negative