Fundamental analysis looks at the macroeconomic factors that affect a company’s business in the longer term. As opposed to technical analysis, the fundamentals of a company are considered as more important than the short term price movements of its stock. One of such fundamentals is the industry.
Each industry sports some differences when it comes to its customer base, market share among firms’ industry-wide growth, regulation and business cycles.
If you learn about how an industry works, you can gain some deeper and better insights on the company’s financial health.
Customers
Some companies cater to only a bunch of customers, while others serve millions of customers, maybe even in different parts of the world.
Generally speaking, it’s a negative sign to see a business depending on only a small number of customers for the larger portion of its sales because a loss of each customer could drastically affect revenues.
Market Share
When you understand a company’s present market share can lead to a deeper understanding of a company’s business.
The fact that the company “owns” an 85 percent market share obviously means that it is the largest market player thus far. Also, this could also suggest that the company has some kind of an “economic moat.”
An economic moat can be considered as a competitive barrier that protects it current and future earnings, along with the market share.
Market share is also important because of economies of scale. When the firm is larger than the rest of its rival, it is more suitable to absorb the high, fixed costs of a capital intensive industry.
Industry Growth
One way to examine a company’s growth potential is an analysis of the extent in which the amount of customers will grow. This is very important because without new customers, a company has to steal market share just for it to grow.
In some market, you can find a zero or negative growth, a factor that demands careful consideration. For instance, a manufacturing company that’s dedicated to creating audio compact cassettes might have been very successful long ago
But the same company would probably be unsuccessful now because of new technologies like smartphones and other gadgets.
Competition
Looking at the competitions of the company can also give you a lot of insights when it comes to understanding the chances of a company to be successful.
Industries that have limited barriers to entry and a large number of competing firms create a difficult operating environment for firms.
One of the largest risks within a highly competitive industry is pricing power. This talks about the ability of a supplier to increase prices and pass those costs on to customers.
Companies that operate in industries with few alternatives have the ability to pass on costs to the customers.
Regulation
Certain industries are heavily regulated due to the role they play and the importance of their products and services. Such regulations can also drastically affect the ability of a company to attract investors.
In industries where one or two companies represent the whole industry for a region, governments usually specify how much profit each company can make.