I.  Security Analysis

A. Macroeconomic and Industry Analysis

• Fundamental analysis - examines determinants of stock value

• Depends on business environment

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1.  International Economics

• Impacts exports, price competition, overseas profits

• Political situation may be a significant consideration

• Impact of exchange rate

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a. Stronger currency

• Imports cheaper

• Exports more expensive

• Local economy hurt

• Overseas profits worth less

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b.  Weaker currency

• Imports more expensive

• Exports cheaper

• Local economy helped

• Overseas profits worth more

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2.  Domestic macroeconomy

a. Key statistics

(1) Gross Domestic Product (GDP)

• Bureau of Economic Analysis

(2) Unemployment rate

• Bureau of Labor Statistics

(3) Inflation

• Bureau of Labor Statistics

(4) Interest rates

• Impacts interest-sensitive industries - housing, consumer durables, business investment

• Federal Reserve Bank of St. Louis

(5) Budget deficit

• Federal Reserve Bank of St. Louis

(6) Sentiment

• Consumers' and producers' optimism or pessimism about economy

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b. Shocks

(1) Demand shocks

• Affects demand for goods and services

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(2) Supply shocks

• Affects production capacity and costs

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c. Government policy

(1) Fiscal policy

• Use government spending and taxation to affect economy

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(2) Monetary policy

• Use money supply and interest rates to affect economy

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(3) Supply-side policies

• Use tax policy to impact incentives and productive capacity

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d. Business cycle

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(1) Industry classification

(a) Cyclical industries - above average sensitivity to the state of the economy

• Good when economy is expanding

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(b) Defensive industries - little sensitivity to the business cycle

• Outperform other industries during a downturn

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(2) Economic indicators

• Calculated by The Conference Board

(a) Leading indicators

• Move in advance of the economy

- Average weekly hours, manufacturing
- Average weekly initial claims for unemployment insurance
- Manufacturer's new orders, consumer goods and materials
- Institute for Supply Management new orders index
- Manufacturer's new orders, nondefense capital goods excluding aircraft
- Building permits, new private housing units
- Stock prices, 500 common stocks
- Leading Credit Index
- Interest rate spread, 10-year Treasury bond less federal funds
- Average consumer expectations for business and economic conditions

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(b) Concurrent indicators

• Move along with the economy

- Employees on nonagricultural payrolls
- Personal income less transfers
- Industrial production
- Manufacturing and trade sales

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(c) Lagging indicators

• Move after the economy moves

- Average duration of unemployment
- Inventories to sales ratio, manufacturing and trade
- Labor cost per unit of output, manufacturing
- Average prime rate
- Commercial and industrial loans
- Consumer installment credit to personal income ratio
- Consumer price index for services

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3.  Industry analysis

• Profitability and stock performance vary by industry

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a. Defining an industry

(1) North American Industrial Classification System (NAICS)

• 4-digit codes considered an industry

(2) Standard and Poor's - 100 industry groups

(3) Value Line Investment Survey - 90 industry groups

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b. Sensitivity to the business cycle

(1) Sensitivity of sales

• Depends on income elasticity of demand

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(2) Operating leverage

• Depends on fixed vs. variable costs

• Greater variable cost => less sensitive to business conditions

• Can reduce costs in downturns

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(3) Financial leverage

• How much debt does a company have?

• Fixed costs, interest has to be paid

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c. Sector rotation

• Shift portfolio depending on the state of the economy

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d. Industry life cycles

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(1) Start-up stage

• New technology or products

• High amount of volatility

• Some firms go out of business

• Rapid growth in sales and earnings

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(2) Consolidation stage

• Industry leaders emerge

• Survivors more stable

• Sales and earnings more easily predicted

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(3) Maturity stage

• Full potential for use by consumers reached

• Product standardized, more competition by price

• Narrower profit margins

• "Cash cows" - take cash flow out instead of reinvesting in industry

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(4) Relative decline

• Slower growth or even shrinkage

• Due to product obsolescence, competition from new suppliers, competition from new products

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e. Lynch's industry classification

• Developed by Peter Lynch

(1) Slow growers

• Large and again companies

• Steady cash flow and high dividends

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(2) Stalwarts

• Large, well-known companies in noncyclical industries

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(3) Fast growers

• Small and aggressive new firms

• Due to broad industry growth or increased market share in mature industries

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(4) Cyclicals

• Sales and profits expand and contract with business cycle

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(5) Turnarounds

• Companies in difficult circumstances

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(6) Asset plays

• Have valuable assets not reflected in stock price

• Real estate, tax benefits, customer lists

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f. Porter's Five Forces

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