Page 166 - DCOM507_STOCK_MARKET_OPERATIONS

Unit 8: Fundamental Analysis 2: Industry Analysis

This period’s actual sales (Q ) Notes
t
A smoothing parameter (a), where
Sales forecast for next period (Q ) = Q + (1 – a)Q
t+1 t t
The initial level of smoothed sales can simply be the average sales for the last few periods. The
smoothing constant is derived by trial and error testing of different smoothing constants between
zero and one, to find the constant that produces the best fit of past sales.

8.4.3 Conditions and Profitability

The worth of a share depends on its return, which in turn depends on the profitability of the
company. It is interesting that growth is an essential variable but its mere presence does not
guarantee profitability. Profitability depends upon the state of competition prevalent in the
industry. Cost control measures adopted by its units and the growth in demand for its products.
While conducting an analysis from the point of view of profitability, some relevant aspects to be
investigated are:

How is the cost allocation done among various heads like raw materials, wages and
overheads? Knowledge about the distribution of costs under various heads is very essential
as this gives an idea to investors about the controllability of costs. Some industries have
much higher overhead costs than others. Labour cost is another area that requires close
scrutiny. This is because finally whether labour is cheap or expensive depends on the
wage level and labour productivity. Labour that apparently looks cheaper may turn out to
be when its productivity is taken into account.

Price of the product of the industry.
Capacity of production-installed, used, unused etc.
Level of capital expenditure required to maintain or increase the productive efficiency of
the industry.

Profitability is another area that calls for a thorough analysis on the part of investors. No
industry can survive in the long run if it is not making profits. This requires thorough investigation
into various aspects of profitability. However, such an analysis can begin by having a bird’s eye
view of the situation. In this context, ratio analysis has been found quite useful. Some of the
important often used are:
Gross Profit Margin ratio

Operating Profit Margin ratio
Rate of Return on Equity
Rate of Return on Total Capital
Ratios are not an end in themselves. But they do indicate possible areas for further investigation.

Technology and Research

Due to increasing competition in general, technology and research play a crucial part in the
growth and survival of a particular industry. However, technology itself is subject to change;
sometimes, very fast, and can lead obsolescence. Thus only those industries, which update
themselves in the field of technology, can attain competitive advantage over others in terms of
the quality, pricing of products etc.

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