Between the economy and the company
Economic analysis tells you whether the economy in general is likely to grow or decline. Industry analysis tells you how each industry is affected under those conditions, and how the various players connected to an industry are likely to react in ways that change its prospects.
The syllabus lists the questions industry analysis must answer:
- 1What is the industry in which the company operates?
- 2How much is it affected by cyclical trends in the economy?
- 3What is the potential industry size?
- 4How has the industry performed in the past, and what drove that performance?
- 5What is the level of competition, and how does it affect the pricing power of the players?
- 6What secular trends affect the industry, and are they causing value migration?
- 7Are there regulatory headwinds or tailwinds?
Industry, business sector, economic sector
Three words are used loosely, and the exam expects you to keep them apart.
Defining the industry is the first step, and the hard one
Several standard classification systems exist: the National Industry Classification (NIC) in India, the Global Industry Classification Standard (GICS), and the North American Industry Classification System (NAICS) in the US. None necessarily captures the substance of an industry. NIC has a single classification for manufacture of passenger cars, so an entry-level compact car maker and a luxury car maker fall in the same class even though their dynamics differ enough for an analyst to treat them as different industries. The challenge grows when a company earns its income in many industries.
PVR Cinemas competes with satellite channels and over-the-top platforms such as Netflix and Hotstar for audiences, and the cinema business also competes with live theatre, live performances and sporting leagues. Define the industry narrowly, as cinema exhibitors, and you overlook those competitors. Define it broadly and you must choose between entertainment media and out-of-home (OOH) entertainment, or fall back to a much broader media and entertainment industry whose segments have their own idiosyncrasies and are not strictly comparable. The choice matters most when the analyst compares financials, finds peer firms and values the company.
Cameras tell the same story. Two decades ago cameras were a standalone product; mobile phones with built-in cameras took the sales of entry-level digital cameras, and today's high-technology phones compete with mid-tier cameras. Define cameras as a standalone industry and you ignore the phone.
The analyst should consider the factors that drive the business and place it in the industry group that shares those drivers. If PVR's business is driven by people's propensity to spend time outside the home, classify it as out-of-home entertainment. If it is driven by their propensity to consume movie content, classify it as entertainment media.
GICS
GICS, widely used in the financial sector by global investors, is a four-tiered hierarchical classification: sectors, industry groups, industries and sub-industries. It has 11 sectors, 25 industry groups, 74 industries and 163 sub-industries (MSCI, March 2023); the syllabus illustrates with the energy sector.
Insurance is an industry; financial services is a business sector; services is an economic sector. A question that calls "financial services" an industry, or "steel" a sector, is testing exactly this vocabulary.
- Economic analysis says whether the economy will grow; industry analysis says how each industry is affected under those conditions and how the players around it will react.
- An industry is a group of firms serving the same customer need with similar products (auto, insurance, steel, telecom, entertainment); a business sector groups related industries (financial services: insurance, banking, credit rating, investment banking); an economic sector is a segment of national output (agriculture, manufacturing, public utilities, services).
- Standard classifications (NIC in India, GICS, NAICS in the US) may miss the substance: NIC puts entry-level and luxury car makers in one class; PVR competes with satellite TV and OTT as well as live theatre and sport; cameras compete with phones. Classify by the factors that actually drive the business.
- GICS is a four-tier hierarchy: 11 sectors, 25 industry groups, 74 industries, 163 sub-industries.