After completing an analysis of the economy and the overall market, if the investor is convinced that the economy and the market are attractive from the point of investing in common stocks, the investor should proceed to consider those industries that promise good prospects in the coming year.
An analysis of the illustration below will reveal how a particular industry’s fortunes can be affected by the external environment. When the Eighth Plan has given the emphasis to the spread of telecommunications, the demand for Jelly-filled cable has gone up. From a stagnant position during late 70s and 80s now the Jelly-filled able industry is buzzing with activity.
In assessing the future prospects of an industry, the four steps to be followed are:
1. Identifying the key factors about the industry
2. Life cycle of the industry
3. Analysis of the competitive position.
4. Segmentation of industry and identifying profitable segment
Identifying the Key Factors:
There are various factors which help in determining the prospects of the industry. They are,
1. Past sales and earnings performance
2. Permanence of the industry
3. Attitude of the government towards the industry
4. Labor conditions
5. Industry share prices relative to industry earnings
Past sales and Earnings Performance: Analyzing the historical performance of the industry is one of the most effective ways to assess the industry. From the data of the past sales and the earnings performance, one has to interpret average levels and stability of performance and growth rates of sales and earnings.
Permanence of the Industry: Permanence is a phenomenon related to the product and technology of the industry. Sometimes an industry is eliminated from the market scene because of another replacement industry that diminishes or eliminates the need for the original industry. An example of this synthetic fibers which is providing a strong alternative to the cotton textile. The factor of permanence assumes considerable importance in assessing the prospects of hi-tech industries.
Attitude of the Government: The attitude of the government towards a particular industry is a very important factor to be considered. The government can help the selected industries in several ways which includes (1) liberalizing the industrial licensing procedures and other statutory control (2) providing liberal financial assistance on soft term (3) extending a more favorable treatment with regard to direct and indirect taxation and (4) ensuring adequate protection from external competition by imposing imports quotas and tariffs. Conversely, the government can also initiate various measures that lend to hamper the growth of an industry.
Labor conditions: The labor conditions in the industry become more important with the strengthening of the labor unions. In industries which are either labor intensive or capital intensive, if the labor performs crucial operations, the possibility of a strike is an important factor to be reckoned.
Industry Share Prices Relative to Industry Earnings: This factor evaluates the share prices of industry relative to the industry earnings. Sometimes in an industry all the factors discussed above may be favorable. But when compared to earning potential of the industry the industry share prices may be very high. This is because when a new technology is developed, or if a market perceives a change in the external environment which affects the industry positively, the investor becomes over zealous to add the securities off rims in this industry, to this portfolio, thereby pushing up the prices. This phenomenon could be seen when the stock prices of firms in the steel industry and molasses industry went up with the decontrol.