Thursday, July 05, 2007

Research Series Part 2 – Industry Knowledge, Trends and Analysis

To continue the research series, Part 1 talked about the importance of doing objective and rigorous research. Part 2 will touch on doing research on a macro-level, which involves a review of megatrends, economic reviews and industry analysis. This will give the investor an overview of the state and health of the economy, and allow him to assess the prospects of a particular industry in which the company is operating in. He should also assess the competitive position of that company with respect to its peers in the same industry, and to determine if it’s the market leader, market follower or market laggard. This aspect will be covered in more detail in a future part of the series on Porter’s Five Forces Analysis.

Megatrends

Megatrends are a form of economic trend whereby asset prices are either consistently increasing, or consistently decreasing. This of course depends on whether there is an economic boom or a recession/depression. Megatrends are usually noticed after a prolonged and sustained overall increase in asset prices for many classes of assets such as equities and properties. For the stock market, megatrends can affect the valuations of companies as rising asset prices also tends to force up prices of equities, to the extent that they may become over-valued. In a bearish economy, asset prices are depressed and this spills over to the stock market as well, with equities being under-valued relative to their earnings capability. Get an idea of megatrends by reading business news, commentaries on the economy and following economic analyses done by reputed business publications.

Inflation, CPI and Unemployment

These three terms are commonly used in determining the state of the economy, and are covered in most economics textbooks in finance and accounting courses. I will not go into too much detail as you can probably get the definition from sites such as www.investopedia.com. Simply put, inflation represents the rise in prices of items in terms of nominal dollar value, such that in real terms, one is poorer than before even with the same spending ability. Assume you have S$1,000 disposable income and the rate of inflation is 5% per year. After 10 years, your spending power would have decreased by 5% per annum for 10 years straight. This makes your S$1,000 probably worth around S$700+ (estimation, I did not use concrete computations as this is just an illustration). Countries with high rates of inflation are called hyper-inflationary economies, and asset prices there tend to be depressed because the money used to buy them becomes worthless very quickly.

CPI stands for consumer price index, and measures consumers’ (people like you and me) spending power in the economy. If CPI is high, it means that people have higher spending power and are spending more than previously. This would give a signal that the economy is healthy and robust and people are having comfortable lives, thus are willing to spend more of their disposable income on necessities and luxuries.


Unemployment rate refers to the % of people in a country who are not gainfully employed, meaning they are of employable age but are not holding down a job. Chronically high unemployment rates signify that the economy is in a recession because companies are making losses and are thus cutting back on staff in order to reduce costs. Singapore currently enjoys a low unemployment rate which seems to indicate that the state of the economy is robust.

Business News


It is important to have a rudimentary knowledge of business and to regularly read up on business developments in and around Singapore and South-East Asia. The recent news mentions the abundance of liquidity flowing in the markets and that private equity firms have been having a field day buying up listed companies in Singapore. Vietnam, China and the Philippines are maintaining very high GDP growth rates of 7% and more. Having such knowledge enables you to make more informed decisions about your investments as they may be exposed to a particular country or industry sector.

Industry Review and Analysis

The most important macro aspect of investing in a company is, of course, the industry analysis. For example, companies such as Reyoung and Star Pharmaceutical belong to the China pharmecutical industry. Capitaland and Keppel Land belong to the property industry, while Ezra and Swiber belong to the oil and gas industry. It is important to have a basic understanding of the industry in which the company you intend to invest in is operating, and to understand the mechanics of it well. Some industries are cyclical, while others have been almost entirely commoditized (micro-chips). Read up as much as you can on the industry from broker’s reports (they sometimes cover certain industries or sectors of the economy), business publications, industry websites (e.g. rigzone.com for oil and gas industry) and general business news. This will prove very important in determining if a company is worth investing in.


In the next few parts of the series, we will look at the company and business level aspects of research. These will include a review of the Annual Report and the important things to look out for, a breakdown of the Profit & Loss, Balance Sheet and Cash Flow Statement. Stay tuned !

4 comments:

fishman said...

though already aware of these fundamentals, it's always refreshing to recap on the above.

looking forward to your views on financial statements!

musicwhiz said...

Thanks fishman,

The next series will probably be about Porter's 5-Forces Analysis for industry analysis. Stay tuned !

hannahzgg said...

Yeah I feel this is a very good sumarry that help us to recap the basics... It is simple and easy to understand :)

musicwhiz said...

Thanks for dropping by hannahhzgg !