True or false: Utility, tobacco, alcohol, cosmetics, and food company stocks are all example of cyclical stocks?
False, defensive
True or false: Utility stocks are sensitive to higher interest rates?
True. These companies are highly leveraged.
Sectors that show their best relative performance at the early-to-middle part of a bull market:
- Credit-related industries
- Construction
- Durable consumer goods
- Transportation
Sectors that show their best relative performance at the middle-to-late part of a bull market:
- Capital goods
- Financials
Sectors that show their best relative performance at the late part of a bull market:
- Non-durable consumer goods
- Utilities
- Energy stocks
Stages of an industry’s life cycle:
- First stage: Characterizd by high growth rates and potentially high profits.
- Second stage: Characterized by rapid growth. Due to consolidation, compared to the first stage, there are fewer companies.
- Third stage: Similar to stage two. Slower growth. The industry’s products begin to face competition from other products and markets may start to become saturated.
- Fourth stage: Growth substantially slows. In some industries, there is no growth at all, or a decline.
3 ways an industry can maintain a good rate of growth:
- Steady penetration of rapidly growing markets
- Accelerating penetration of markets w/ stable growth rates
- Accelerating penetration of rapidly growing markets
Unit costs
1/2 major factors that influence the pattern of industry profits. For most industries, as output increases in the early stages of growth, cost per unit decreases due to economies of scale.
Learning curve
A graph that illustrates the output and the industry’s unit cost.
- This curve begins to flatten as unit costs stop falling w/ increases in production.
Unit pricing
1/2 major factors that influnce the pattern of industry profits. With this, attention is more paid to companies w/ large market share. The pricing strategies of industry leaders have an impact on the profitability of the entire industry.
Umbrella pricing
A type of pricing strategy where the market leaders set their prices just above the unit costs of the industry’s highest cost producers. This allows the low-cost producers to earn an attractive rate of return, while other producers earn only modest returns.
- Cartels can generate a price umbrella effect, enabling less efficient rivals to charge higher prices than they might otherwise be able to
Learning curve pricing strategy
Low-cost producers use their cost advantage by regularly lowering prices. This puts pressure on the high-cost producers to improve efficiency in order to maintain profitability
True or false: Counter-cyclical stocks and defensive stocks are the same thing?
False, counter cyclical stocks do better during economic hardship, whereas defensive stocks are just more resistant and suffer less than cyclical stocks.
Monopsony
A market w/ a single buyer.
- Opposite of a monopoly.
Common examples of things that create barriers to entry:
- Market share (brand name)
- Possession of proprietary knowledge (patents/research)
- Ownership of raw materials
- Regulatory things
Items important for fundamental analysis
- A firm’s financial statements
- Details regarding the firm’s product line
- The experience and expertise of the firm’s mgmt
- The outlook for the industry
Components of company analysis
- Product line analysis
- Quality of mgmt analysis
- Analysis of costs and sources of revenue and growth
Product line analysis
Now that industry analysis has been performed, product line analysis is often the first step of fundamental analysis. If a firm produces one product, the industry’s potential for growth will heavily influence the growth potential for the firm. If a firm operates in multiple product lines, each product must be analyzed and then an overall prospect for the company can be deciphered from a weighting of the individual product line analysis. This requires an understanding of market share.
Analysis of costs and sources of revenue and growth
This often requires analysis of a firm’s supply chain. Often, analysts look to see if a firm is reliant on a small # of suppliers. Analysts usually look at a firms’ policies to determine how well it could cope w/ future uncertainities.
Key components of FSA:
- Operating leverage
- Financial leverage
Operating leverage
The degree to which a firm or project relies on fixed rather than variable costs.
Calculation: FC ÷ (FC + VC)
- The higher the degree of operating leverage, the greater the potential dangers from forecasting risk (small error made in forecasting sales can be magnified into large errors in CF projections).
- Companies w/ high operating leverage will have longer breakeven points.
True or false: Firms w/ higher variable costs will have faster margin growth as opposed to firms w/ higher fixed costs if sales increase?
False, firms w/ higher operating leverage will have faster margin growth if sales increase.
This is only true is the total costs are the same!!!!!
BE point calculation
FC ÷ contribution margin
Contribution margin
Sales price - VC
