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Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Eighth Edition by Frank K Reilly & Keith C Brown Chapter 13 Chapter 13 Industry Analysis Questions to be answered: • Is there a difference between the returns for alternative industries during specific time periods? What is the implication of these results? • Is there consistency in Chapter 13 Industry Analysis • Is the performance for firms within an industry consistent? What is the implication of these results for industry and company analysis? • Is there a difference in risk among industries? What are the implications of these results for industry analysis? Chapter 13 Industry Analysis • Given the present value of cash flow valuation techniques, how does an analyst determine the value of an industry using the DDM and assuming constant growth or two stage growth? • How does an analyst determine the value of an industry using the free cash flow to equity (FCFE) model with constant growth or two stage growth? • What happens to risk for individual industries over time? What does this imply for industry analysis? Chapter 13 Industry Analysis • What are the steps involved in estimating earnings per share for an industry? • What are the stages in the industrial life cycle and how does the life cycle stage affect the sales estimate for an industry? • What are the five basic competitive forces that determine the intensity of competition in an industry and thus, its rate of return on capital? Chapter 13 Industry Analysis • How does the estimating procedure for the operating profit differ for the aggregate market versus an industry? • What are the two alternative procedures for estimating an industry earnings multiplier? Chapter 13 Industry Analysis • What is involved in a macroanalysis of the industry earnings multiplier? • What are the steps in the microanalysis of an industry earnings multiplier? • After you estimate an industry earnings multiplier, how you determine if the industry’s multiplier is relatively high or low? Chapter 13 Industry Analysis • How industries differ in terms of what dictates their return on assets? • What are some of the unique factors that must be considered in global industry analysis? Why Do Industry Analysis? • Help find profitable investment opportunities • Part of the three-step, top-down plan for valuing individual companies and selecting stocks for a portfolio What Do We Learn From Industry Analysis? • Is there a difference between the returns for alternative industries during specific time periods? • Will an industry that performs well in one period continue to perform well in the future? That is, can we use past relationships between the market and an individual industry to predict future trends for the industry? Industry Valuation Using the Free Cash Flow to Equity (FCFE) Model • The Constant Growth FCFE Model FCFE1 V = k −g • The Two-Stage Growth FCFE Model The Earnings Multiple Technique • Estimating earnings per share – start with forecasting sales per share • Industrial life cycle • Input-output analysis • Industry-aggregate economy relationship – earnings forecasting and analysis of industry competition • • • • • competitive strategy competitive environment industry operating profit margin industry earnings estimate industry earnings multiplier Industry Profit Margin Forecast • Industry’s operating profit margin (EBITDA / Sales) – Depreciation expense – interest expense – tax rate Industry Profit Margin Forecast Industry’s operating profit margin (EBITDA / Sales) • Regression analysis • Time series analysis • Long-term consideration including competitive structure Industry Profit Margin Forecast Depreciation expense • Generally increasing time series • Specific estimate technique using the depreciation expense/PPE ratio • Subtract depreciation from operating profit margin to determine industry’s net before interest and taxes Industry Profit Margin Forecast Interest expense is a function of financial leverage and interest rates Calculate the annual total asset turnover (TATO) Use your current sales estimate and an estimate of TATO to estimate total assets next year Calculate the annual long-term (interest bearing) debt as a percent of total assets, Estimate long-term debt for the next year Industry Profit Margin Forecast Interest expense (cont.) Calculate the annual interest cost as a percent of long-term debt and analyze the trend Estimate next year’s interest cost of debt for this industry based upon your prior estimate of market yields Estimate interest expense based on the following estimates: (Interest Cost of Debt) (Outstanding Long-Term Debt) Industry Profit Margin Forecast Tax rate • Regression analysis • Time series plot • After estimating the tax rate, multiply the EBT per share value by (1 - tax rate) to estimate earnings per share • Derive an estimate of industry’s net profit margin as a check on your EPS estimate Estimating an Industry Earnings Multiplier • Macroanalysis – relationship between multiplier for the industry and the market – variables that influence the multiplier: • required rate of return (k) – function of the nominal risk-free rate plus a risk premium • expected growth rate of earnings and dividend • dividend payout ratio Estimating an Industry Earnings Multiplier • Microanalysis – Estimate the variables that influence the industry earnings multiplier and compare them to the comparable values for the market P/E – Industry multiplier versus the market multiplier – Comparing dividend-payout ratios – Estimating the required rate of return (k) – Estimating the expected growth rate (g) g = Retention Rate (b) X Return on Equity (ROE) = (b) X (ROE) Other Relative Valuation Ratios • Price-to-book value ratios (P/BV) • Price-to-cash flow ratios (P/CF) • Price-to-sales ratios (P/S) Global Industry Analysis • The macroeconomic environment in the major producing and consuming countries for this industry • An overall analysis of the significant companies in the industry and the products they produce • What are the accounting differences by country and how these differences impact the relative valuation ratios? • What is the effect of currency exchange rate trends for the major countries? The Internet Investments Online http://www.lf.com http://healthcaredistribution.org http://retailindustry.about.com http://valuationrespurces.com http://www.nacds.org End of Chapter 13 –Industry Analysis Future topics Chapter 14 Company Analysis and Stock Selection • Value • Growth • Strategies ... there consistency in Chapter 13 Industry Analysis • Is the performance for firms within an industry consistent? What is the implication of these results for industry and company analysis? • Is there... for industry analysis? Chapter 13 Industry Analysis • Given the present value of cash flow valuation techniques, how does an analyst determine the value of an industry using the DDM and assuming... for industry analysis? Chapter 13 Industry Analysis • What are the steps involved in estimating earnings per share for an industry? • What are the stages in the industrial life cycle and how does
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