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Business Analysis. We will study the first phase of business analysis, focusing on internal and external analysis. Where We Are Going. Chapter 3. First Phase of Security Analysis. Business Analysis. GAAP Financial Statements. Financial Statement Analysis. Forecast

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Business Analysis

We will study the first phase of business analysis, focusing on internal and external analysis

Where We Are Going

Chapter 3


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First Phase of Security Analysis

Business Analysis

GAAP

Financial

Statements

Financial Statement

Analysis

Forecast

Assumptions

Valuation

Time

Historical Periods

Valuation Date

Forecast Periods


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Understand the business

Goal of this chapter is to develop a way of analyzing an unfamiliar business

The Key to Developing a Forecast is to


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Business Analysis

  • Highlights issues we need to study further in the financial statement analysis stage

  • Business analysis usually does not provide numerical answers for valuation assumption, then what’s its purpose?


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Financial Statement Analysis

  • Identifies concerns that require more detailed business analysis


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Internal Analysis Studies a Firm’s. . .

Mission

Human resources

Product life cycle

Marketing and selling

Pricing and differentiation

Supply chain

Finance

Investment priorities

Products and services


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External Analysis Analyzes

  • Industry economics

  • Individual competitors

  • Customers

  • Governmental regulations

  • Q: What differentiates between external and internal analysis?


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External Analysis—Industry Economics

This study determines the target firm's

  • Returns

    • High return attract more competition

    • Intense competition in turn lowers return

  • Profitability

  • Cash flow

    Based on the Porter’s Five Forces Framework


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Porter's Five Forces Framework: Forces Driving Industry Competition

Potential Entrants

Existing

Competitive

Rivalry

Buyers

Suppliers

Substitutes


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External Analysis—Individual Competitors

Goal:

  • To understand the existing rivalry on a macroeconomic level

  • Factors to increase rivalry

    • More competitors

    • Low industry growth

    • Limited product differentiation

    • High fixed costs

    • Excess industry capacity


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External Analysis—Potential Entrants

Goals:

  • To know numbers of potential competitors

  • How they will affect competitive rivalry

  • Barriers to entry:

    • Economies of scale

    • Product differentiations

    • High capital needs

    • Difficulty of obtaining certain resources

    • Access to distribution channels

    • Cost disadvantages

    • Specialized technology and patents


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External Analysis—Substitute Products

Goals:

  • To understand how substitute products can remove profits

  • To consider the available substitute products

  • Example:

    • Coffee vs. Tea

    • Rice vs. Flour

    • Coke vs. Pepsi

    • …..


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External Analysis—Buyers

Goal:

  • To understand the customers' strong bargaining position

  • Factors to increase bargaining power

    • Homogeneous product

    • Many suppliers

    • Customers buy large quantity

    • Customers act in concert


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External Analysis—Suppliers

Goal:

  • Understand that suppliers generally have more bargaining power to raise prices and lower quality if there are only a few of them and if there are not many substitutions for their products.

  • Example:

    • The Major League Baseball Players Association

    • Microsoft?


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Individual Competitor Assessment

Goal:

  • Understand specific key strategies of key competitors on a microeconomic level with an eye toward how each will affect the target company

  • Questions to ask when analyzing individual competitor

    • P. 48


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Individual Competitor Assessment Continued

Includes:

  • Strategies

  • Products

  • Marketing

  • Supply chain

  • Profitability


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Customer Analysis

Goal:

  • To understand how the customers’ needs drive demand

    • Price vs. quality

    • Trends in customers’ needs

    • Understand both the intermediate channels and the ultimate customers

    • Demographic trends, purchasing habits, attitudes and usage information


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Governmental and Regulatory Analysis

Goal:

  • To understand the governmental and regulatory environment of a firm

    • Regulated industry: utilities

    • Pollution standards

    • Licensing requirements

    • Food and drug safety rules


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Mission

Internal Analysis

Products and services

Product life cycle

Pricing and differentiation

Marketing and selling strategies

Supply chain

Human resources

Investment priorities

Finance/accounting


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Internal Analysis—Mission

What the firm hopes to accomplish

  • Understanding the company’s mission puts these business strategies and actions in perspective so that the analyst can better predict the firm’s future


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Internal Analysis—Products and Services

  • What do products and services do?

  • How does the customer use them?

  • What is the market scope? Defined according to

    • Geographic area

    • Certain technology

    • Customer type

  • What are the depth and breadth of the firms product?

    • Amazon.com vs. William Wrigley Jr.


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Internal Analysis—Product Life Cycle

Sales

Introduction Growth Maturity Decline

Phase

  • Costs vary with these stages

    • R&D, promotion

  • Firms or industries spend different amounts of time in each phase


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Internal Analysis—Pricing and Differentiation

  • The more differentiated the product, the less competition focuses on price

  • Differentiation vs. Price Competition

    • The more differentiated the product the less competition focuses on prices

      • Wal-Mart’s vs. Nordstrom’s

      • Natural Foods vs. Supermarkets


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Internal Analysis—Marketing and Selling Strategies

Goal:

  • To understand the firm's strategy for bringing the product to the customer

    • Advertising: TV, radio, newspaper, magazines or internet?

    • Promotions: price discounts, free product, customer’s incentives


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Internal Analysis—Supply Chain

Goal:

  • To understand how each part works in order to project future cash flow

  • A large percentage of costs occur in the supply chain


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Internal Analysis—Supply Chain Includes

  • Elements: importance differs for different type of firms

    • Purchasing

    • Manufacturing

    • Research and development

    • Distribution


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Internal Analysis—Human Resources

Goal:

  • To understand the strengths and weaknesses on the people side

    • Leadership ability and style

    • Core competencies

      • The special skills and abilities that allow it to be successful


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Internal Analysis—Investment Priorities

Goal:

  • To know what makes a firm successful through understanding its investment priorities

  • Priority of strategies: what a firm will do if a competitor tires to interfere with its business

    • Advertising

    • Pricing

    • Capital investment

    • Legal maneuvers


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Internal Analysis—Finance/Accounting

Goal:

  • To understand how the firm's accounting methods, estimates, and judgments affect the financial statements

  • Cost structures

    • High margins vs. large volume


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Summary

We have learned:

  • Why business analysis is crucial to security valuation

  • How to prepare an external analysis of the firm


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Summary Continued

  • How to prepare an internal analysis of the firm

  • Where to get information for business analysis

    • Annual reports

    • Magazine

    • Newspapers

    • Company web site

    • Government information

    • Analyst reports

    • Internet search


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