Industry analysis is a tool that gives investors an A to Z insight into any industry. This encompasses insights about the level of competition in the industry, demand and supply situation, how easily can new companies enter the industry etc. The analysis takes into account external and internal factors that can impact an industry.
In this article
What Does this Analysis Entail?
Before placing big bucks on any company, understanding the industry is extremely important. Say you are investing in a pharmaceutical company, there are a few things you will have to keep in mind.
For example drug regulations and patenting, demand situation of medicines, FDA regulations and more.
Such factors tell investors which are the threats that the pharma industry faces, which factors go in favour and the competitive landscape of the industry. Thorough industry analysis will help you to understand such unique aspects of any industry.
Who Can Benefit From an Industry Analysis?
Industry analysis is for anyone who is interested in investing in a company; large scale investors, institutional investors and even retail investors.
Understanding the industry is a key component of understanding a company. So it helps investors and other stakeholders to position a company against other peers from the same industry. It gives investors a picture of roadblocks and opportunities that come in the way of the company and its industry
How to Conduct Industry Analysis?
There are many ways in which you can do this. However, we have zeroed down on two of the best methods to help you analyse an industry:
- Porter’s Five Forces to Analyse Stocks
- SWOT Analysis
Porter’s Five Forces
Michael Porter, an American academic, devised five forces in his book Competitive Strategy: Techniques for Analyzing Industries and Competitors to conduct a thorough study of any industry.
Here are the five forces:
Rivalry with Peers
It is important to know about the position of a company wrt peers from the same industry. You cannot rank a manufacturing company against a pharmaceutical company for comparison. For the same, one needs to look at the competition levels. Competition and the fear of losing out on business to a peer company keep companies on their toes and helps them innovate. According to Porter, competition is intense when there are more players, when the products are similar and the companies are fighting to find an edge over other products, in case of perishable products, etc.
Threat of New Competition
The second competitive force that Porter emphasizes is the ability of new companies to enter the industry and intensify the competition. Industries, where it is difficult for new competitors to enter, benefit extended periods profitability and very limited rivalry. Competition basically tells us how difficult it is for the company to make money and how far it has been successful. The success, therefore, will translate into the stock prices.
Threat of Substitutes
Substitutes are products that can be used in place of the other. For example, Domino’s Pizza and Pizza Hut pizza are substitutes for each other. If the price of one rises, the demand for the other one will increase. Since it is so easy to switch to the substitute on account of any change such as a price rise or quality drop, the threat remains and the pressure to continuously perform better and in a cost-efficient way is essential. The better the company executes against its substitutes, the higher it goes.
Bargaining Power of Buyers
This power refers to the power buyers have where they can force the sellers to give them better quality products and at lower prices. The bargaining power is high in the following cases:
- if the number of buyers is lesser than the number of suppliers in the market,
- if the buyer has more similar products in the market and depends less on a particular supplier and if the switching cost is low.
This will help you understand how the company’s profits will be impacted in the long term.
Bargaining Power of Suppliers
Many small and mid-sized companies face a threat from an industry where the suppliers hold bargaining powers.
Imagine a fashion company that has a specific dress line and design that makes it famous but needs a specific cloth type available only with a handful of suppliers. In such cases, the suppliers can raise the prices, which will impact the dress’s final cost and impact the brand’s business.
Large corporations may remain unaffected by this power since they have the resources to establish an extensive supplier network and create buyers’ bargaining power instead.
These five forces will be instrumental in forming a comprehensive industrial analysis report.
SWOT analysis is one of the most common analytical tools. It is an all-weather tool and can be used in business, personal life, or anything. Since we are talking about industry analysis here, let’s understand how this tool can come in handy for our purpose.
Put merely, SWOT stands for Strengths, Weaknesses, Opportunities and Threats. So if you are running a SWOT analysis on an industry you will have to chart out the:
Strengths: Factors that give the industry an edge over the others
Weaknesses: Factors that keep businesses at a disadvantage
Opportunities: Factors present in the economy and external environment that positively impact the performance and profitability
Threats: Factors present in the economy and external environment that negatively impact the performance and profitability
DID YOU KNOW
Sector vs Industry
How often do you find yourself confused between the two words? There exists a thin line of difference between the two terms. A sector is a broader umbrella than an industry. Any economy in the world has a financial sector and multiple industries comprise the financial sector: banking, insurance and other financial services.
How Does Industry Analysis Help In-Stock Selection?
Investing in a stock is never a standalone decision. Say you want to invest in HDFC Bank Ltd., it is important to analyse HDFC Bank, its loan book, it’s NPAs and other banking specific factors. However, your research should not stop there. You need to look at how the banking sector performed in the past few years, what it looks like in the near future, how risky it is and if the sector’s risk level aligns with your risk level and then repeats this exercise for every stock. Industry analysis is thus an important step in fundamental analysis and can help you pick a stock that matches your risk profile and investment objectives.