Investment Return for Industry Analysis

To achieve excess equity returns on a risk-adjusted basis, an investor must find companies that can earn return on equity (ROE) above the required rate of return and do this on a sustained basis. For this reason, global industry analysis centers on an examination of sources growth and sustainability of competitive advantage.

Investment Return Expectations and Demand Analysis

Growth must be distinguished from level. A high profit level may yield high current cash flows for valuation purposes, but there is also the question of how these cash flows will grow. Continued reinvestment opportunities in positive net present value investment opportunities will create growth. Curtailment of capital expenditures may yield high current cash flows at the expense of future growth.

Value analysis begins with an examination of demand conditions. The concepts of complements and substitutes help, but demand analysis is quite complex. Usually, surveys of demand as well as explanatory regressions are used to try to estimate demand. Demand is the target for all capacity, location, inventory, and production decisions. Often, the analyst tries to find a leading indicator to help give some forecast of demand.

In the global context, demand means worldwide demand. One cannot simply define the automobile market as a domestic market. A starting point, then, is a set of forecasts of global and country-specific GDP figures. The analyst will want to estimate the sensitivity of sales to global and national GDP changes.

Country analysis is important for demand analysis, because most companies tend to focus on specific regions. Most European car manufacturers tend to sell and produce outside of Europe, but the European car market is their primary market. An increase in demand for cars in Europe will affect them more than it will affect Japanese car producers.

Investment Return Expectations and Industry Value Chain

Sources of value come from using inputs to produce outputs in the value chain. The value chain is the set of transformations in moving from raw materials to product or service delivery. This chain can involve many companies and countries. some producing intermediate goods, some producing finished consumer goods, and some delivering finished goods to the consumer. From the point of view of an intermediate goods producer, basic raw materials are considered to be upstream in the value chain, and transformations closer to the consumer are considered downstream.

Within the value chain, each transformation adds value. Value chain analysis can be used to determine how much value is added at each step. The value added at each transformation stage is partly a function of four major factors: The learning (experience) curve: As company produces more output, they gain experience, so that the cost per unit product declines. Economies of scale: As a company expands, its fixed c a larger output, and average costs decline over a range of output. Economies of scope: As any produces related products, experience and reputation with one product may spill over to another product. Network externalities: Some products and services gain value as more consumers use them, so that they are able to share something popular.

Value chain analysis can help analyst better understanding of industry. For the analyst, strategy of predicting dividends and dividend growth rates must be based on profit migration in the value chain. It is also a useful framework for company managers. For example, company managers can break the computer industry down into value chain stages: equipment, materials, components, product design, assembly, operating system, application software , sales and distribution, and field service.