To pick the right stocks, look for those industries which are growing at a faster rate than the overall economy.
Investment science literature documents very well the need for industry analysis while making investment decisions. Basically, it involves reviewing information on current economic market conditions with special reference to the industries in which an investor proposes to invest his money. However, not much is discussed in detail about how an investor should go about the industry analysis. Let us try to fill that gap.
Objective of analysis
Industries are classified based on the segment to which they belong such as manufacturing, services, construction, retail, textiles, etc. Another classification is based on the indexes such as BSE Sensex, NSE NIFTY, Down Jones Indexes, FTSE, and the like. As an investor, one should know the objective of analysis.
For instance, your objective is to identify industries which are performing well and which have good prospects. Then, you should choose firms which are listed in India. Further, look for those industries which are growing at a faster rate than that of the overall economy. For instance, the most-talked about industries within information technology are artificial intelligence, virtual reality, and in automobile segment electric cars and self-driving motor vehicles.
Choose the right industry
Each industry has many sub-industries. For instance, automobile is a broad industry within which we have passenger and commercial vehicles. Passenger segment is broadly further classified into two-wheelers and four-wheelers. Within four-wheelers, further classifications are made based on horse power, seating capacity, etc. Hence, it is important to focus on the relevant industry.
Read relevant reports
Having identified your industries according to your objective analysis, the next step is to review the relevant reports. Start reading the reports with sufficient empirical data and decide whether it make sense to dig deeper. Pick up a most recent report and envisage its relevancy in the current market, this is the key point. However, one should not depend on existing reports only as the market always behaves differently, and factors responsible for success change constantly.
Perform a demand-supply analysis
Demand and supply are the primary factors in any market. So, it becomes obvious to look into the demand-supply scenario for the products manufactured by the chosen industry. This could be done by investigating its past trends and forecasting future outlook.
Engage Porter’s five forces
This is the vital part in your analysis. In this, as an investor you should study competitive scenario using Porter’s Five Forces model. This is a proven and well-established model. Under this model, each industry is analysed using five important parameters such as barriers to entry, supplier power, threat of substitutes, buyer power and the intensity of rivalry in the competitive landscape.
Identify and understand industry dynamics
Under industry dynamics, you need to identify what are the industry drivers and assess the major variables driving the process of entry, innovation, growth, etc. You need to understand these variables along with how co-evolution of technologies and institutions helps the same.
To conclude, before investing one should know how to do industry analysis by following the above six simple steps.
The writer is professor and dean, School of Commerce and Management, Central University of Tamil Nadu, Thiruvarur