Business Analysis

1
Business Analysis
Where We Are Going

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

Chapter 3
2
First Phase of Security
Analysis
Business Analysis
GAAP Financial Statements
Financial Statement Analysis
Forecast Assumptions
Valuation
Time
Historical Periods
Valuation Date
Forecast Periods
3
The Key to Developing a Forecast is to

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

4
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
  whats its purpose?

5
Financial Statement Analysis

• Identifies concerns that require more detailed
  business analysis

6
Internal Analysis Studies a Firms. . .
Mission
Human resources
Product life cycle
Marketing and selling
Pricing and differentiation
Finance
Supply chain
Investment priorities
Products and services
7
External Analysis Analyzes

• Industry economics
• Individual competitors
• Customers
• Governmental regulations
• Q What differentiates between external and
  internal analysis?

8
External AnalysisIndustry 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 Porters Five Forces Framework

9
Porter's Five Forces Framework Forces
Driving Industry Competition
Potential Entrants
Existing Competitive Rivalry
Suppliers
Buyers
Substitutes
10
External AnalysisIndividual 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

11
External AnalysisPotential 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

12
External AnalysisSubstitute 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
• ..

13
External AnalysisBuyers

• 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

14
External AnalysisSuppliers

• 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?

15
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

16
Individual Competitor Assessment
Continued

• Includes
• Strategies
• Products
• Marketing
• Supply chain
• Profitability

17
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

18
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

19
Internal Analysis

• Mission

Products and services
Product life cycle
Pricing and differentiation
Marketing and selling strategies
Supply chain
Human resources
Investment priorities
Finance/accounting
20
Internal AnalysisMission

• What the firm hopes to accomplish
• Understanding the companys mission puts these
  business strategies and actions in perspective so
  that the analyst can better predict the firms
  future

21
Internal AnalysisProducts 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.

22
Internal AnalysisProduct Life Cycle
Sales
Introduction Growth Maturity
Decline Phase

• Costs vary with these stages
• RD, promotion
• Firms or industries spend different amounts of
  time in each phase

23
Internal AnalysisPricing 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-Marts vs. Nordstroms
• Natural Foods vs. Supermarkets

24
Internal AnalysisMarketing 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,
  customers incentives

25
Internal AnalysisSupply 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

26
Internal AnalysisSupply Chain Includes

• Elements importance differs for different type
  of firms
• Purchasing
• Manufacturing
• Research and development
• Distribution

27
Internal AnalysisHuman 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

28
Internal AnalysisInvestment 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

29
Internal AnalysisFinance/Accounting

• Goal
• To understand how the firm's accounting methods,
  estimates, and judgments affect the financial
  statements
• Cost structures
• High margins vs. large volume

30
Summary

• We have learned
• Why business analysis is crucial to security
  valuation
• How to prepare an external analysis of the firm

31
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