Security Analysis: Part 2 Industry Analysis

The security analyst who knows economics intimately is well started on the path to effective and useful security analysis. The second step is to do a careful industry analysis. Individual stock prices are tied to the health of the industry sector it belongs to. It makes sense to examine the demands within an industry which put pressure on individual firms in order to identify the companies that show healthy promise. Stability and growth can be predicted to some extent by understanding several key issues:

1. The Essential Characteristics of the Industry: Is this industry narrowly defined or does it cover a wide area? Are there many competing companies or just a few?

2. The Regulatory Arena for the Target Industry: Is this industry regulated? (Utilities, for instance).

3. The Impact 0f Labor on the Industry: Does the industry rely on labor that has contentious relations with employers or does it have trouble recruiting qualified employees?

4. Technological Influences on the Industry: In order to keep robust does this industry depend on new developments in technology or is the technology that drives the industry stable?

5. Economic Variables that Impact the Industry: Is the demand for the industry's output likely to remain stable or is it tied to economic ups and downs?

6. Supply, Demand and the Future: Does this industry compete with other industries for resources? (For instance does your targeted industry use massive amounts of water and compete with agribusiness, fish and wildlife concerns, or major cities for available water?)

Remember that the purpose of security analysis is to identify value. The search for value within the key industry groups (industry analysis) demands an intimate understanding of industry sector trends. Become familiar with industry analysis by reading business publications, studying investor sites, and following the performances of industrial sectors. Here are two places to get started:

• Go to http://moneycentral.msn.com/investor/market/top10industries.asp to find their list of top ten best performing industries and top ten worst performing industries. The list is updated every night.

• Standard and Poor's and MSCI have developed the four tier Global Industry Classification Standard to help provide an analytic frame of reference that classifies global firms. This greatly eases and expedites the process of sector analysis. Investors use the structure as the base for security analysis of industry benchmarks, sector exchange traded funds, and other sector and industry products (http://www.advisorinsight.com/site_map.html ).

• Hoovers Online offers a comprehensive list of industries which they list within their own proprietary industry structure. http://www.hoovers.com/free/ind/dir.xhtml . Hoovers also has an Industry Watch tab you can access to view video interviews with industry leaders.

The most commonly recognized major industry groups (sectors) from the S&P Sector Scorecard are listed below with a few examples of segments within the broader sector headings.

1. Consumer Discretionary: Apparel Retail, Auto Parts, Consumer Electronics, Home Furnishings, Movies and Entertainment
2. Consumer Staples: Food Distributors, Personal Products, Brewers
3. Energy: Oil and Gas Drilling, Oil and Gas Exploration,
4. Financials: Consumer Finance, Insurance Brokers, Multi Line Insurance, Property and Casualty Insurance
5. Health Care: Biotechnology, Health Care Supplies, Managed Health Care, Pharmaceuticals
6. Industrials: Aerospace and Defense, Airlines, Environmental Services, Trucking,
7. Information Technology: Computer Application Software, Computer Hardware,
8. Materials: Forest Products, Metal and Glass Containers
9. Telecommunications: Cellular Telephone Services, Telephone Equipment Installation,
10. Electric Utilities: Electric Utilities, Water Utilities

Industry analysis is inextricably linked to economic analysis and is a continuation of the brush stroke as you paint your security analysis picture. Keep in mind that most industries do not fit your analytical picture for long. They move within the economic cycle and within their own growth cycle which is heavily influenced by economic events. Investors look for an industry that is robust, produces big increases in stock value and is minimally affected by bumps in the economy.