There is yet another challenge in that analyzing specific industry groups usually falls on a small segment of analysts who specialize in that industry.
This poses two serious concerns. First, a company judged by industry spe- cialists, no matter how well it is performing, is often given the same general value by the market as is the industry itself. If the industry is depressed, even a superior company within that industry can face serious stock mar- ket problems.
Second, the majority of analysts who fully understand the ramifications of a particular industry rarely change the relative rankings of major com- panies within that industry. If you are seen as number three in the industry, you are usually the number three forever, with that P/E seen as the norm for your company, unless there is a major company event or breakthrough of some kind. Moreover, most of these industry analysts don’t always repre- sent a sufficiently large number to warrant devoting a major portion of an investor relations effort to them. It therefore becomes necessary to deal with a larger group of analysts functioning in other contexts, and in other organ- izations, who are not as well versed in the ramifications of a particular industry as are the industry specialists, but who may nevertheless see other values. The communications effort then becomes more challenging. Not only must the company be explained and sold to analysts, but the complex specialized differences in dealing with the industry and the company and analyzing it must be made clear.
The problem of specialization also arises frequently in dealing with companies with large international operations. Even in today’s interna- tional environment, where more companies than ever before have some degree of international activity, there are still a relatively small number of American analysts who feel they have the broader international economic background to properly assess a company with significant international activity. Too many others tend to ignore such companies and move on to those easier to understand. There are, after all, more companies in the broader economic sphere than any one analyst can follow. At the same time, there are analysts who specialize in dealing with only one or two compa- nies, particularly if those companies are large enough to represent a major factor in the international economic scene.
These are the significant financial factors that must be communicated in judging a company. It should be clear, however, that in dealing with ana- lysts and others who judge companies, numbers shouldn’t be presumed to speak for themselves. They never do. They require elucidation and expla- nation. This is why financial statements have footnotes. It can’t be repeated too often—a corporation’s statistics freeze the picture as of the date of those statistics, and corporations are dynamic entities.
Prognostication for an entire industry is somewhat easier, at least within a limited range of time, than it is for any one company within that industry. The economic indicators of an industry are rather simple to define.
If consumer spending is down as a result of economic recession, for exam- ple, or the economy is in a period of high consumer debt such as existed in late 1995 and into 1996, it’s reasonable to assume that retail purchases in certain industries, such as appliances and apparel, will have trouble achieving earnings records. Competitive factors, such as online and catalog sales, adversely affected retail chains. If there are basic material shortages, with no relief in sight, it’s reasonable to assume that those industries using those materials will have problems. In good economic times, the purchas- ing power increases, but selling labor gets scarcer.
When transistors were invented, transistor manufacturers enjoyed a boom in those products that used transistors, such as miniature portable radios and portable tape recorders. But then as the industry became satu- rated with transistor manufacturers, and technology reduced the cost of transistors, it became impossible for any company to compete successfully and with very high margins, and the transistor stocks fell on their faces.
New technology helps, but is volatile. The advent of the Pentium chip
Analysis and Analysts 143
caused Intel to soar—until Cyrix came up with a cheaper chip. Technology, analysts know, is a two-edged sword.
On the other hand, when a new industry emerges, such as computers, there are a new set of problems and opportunities. At first, there was a shortage of analysts and investors who fully understood the nature of the industry and where it might go. Then, as it began to grow and mature in the United States, new competitive forces came into play. No sooner did analysts and investors begin to grasp the basics of the new industry when both new technology and competition changed the scene. In the beginning, computer stocks, such as Compaq and Lotus, were at first undervalued, and then, as the companies broke growth records, moved into new com- petitive contexts that few analysts really understood. By the time the indus- try had matured, shares of market had shifted, markets became saturated, new technology changed and challenged leading companies, and there were new economic configurations that were unfamiliar to most investors. By the time the financial community began to understand Compaq, it was a mature company, revaluated its market, and redesigned its product line and marketing approach. By the time the financial community began to under- stand the pioneer Lotus, the company ran into marketing problems, and wound up being acquired by IBM. IBM,which had been overwhelmed by Dell and Compaq (now H-P), and dropped from its leadership position, began it’s own comeback. At the same time, small companies get very big very fast—look at the giant Microsoft—and big names and former high fliers, like WordPerfect,virtually disappeared. Now, with the burgeoning of the internet, and the growth of communications technology (e.g. the cellu- lar phone), things continue to change. As the popular industry writer, John C. Dvorak, puts it, “everything you learned this week will be obsolete by this time next week.” This is how a new industry affects the financial com- munity, in which technology moves faster than analysts can fully under- stand its nuances and ramifications.
Industry analysis is not without problems for the investor relations pro- fessional. Analysts tend to minimize, for example, the company that is out- performing its peers. They frequently fail to understand longer term industry trends, or the effects of new technology on the performance of a company, nor do they readily accept turnaround situations early in the turn- around performance. Despite all the warning signs, in 1981 analysts still expected $100 oil in the energy industry. IBM,not long ago, was consid- ered dead. Mini-mills saved a part of the steel industry. Perspective seems to be a foreign word to the finance industry.
Sometimes industry analysts find themselves susceptible to the same kind of short-term response to which the individual investor is victim. One of the groups to be hit when it was first announced that the plastic, polyvinyl chloride (PVC), was a factor in producing cancer in both the PVC industrial worker and the consumer was the plastics industry. Plastics analysts felt that most plastics manufacturers would be subject to regula- tion that would either curtail production or involve large capital invest- ment in safety equipment. It took a considerable amount of time, during which plastic stocks were adversely affected, for the analysts to sort out those companies that were unaffected, or had already built safety factors into their production.
The problem of environmental pollution lends itself to a similar poten- tial for overreaction. Many industries—paper, steel, chemical, utilities—are now subject to production strictures that will affect their processes, and attendant costs, to varying degrees. But there are relatively few facts avail- able on how these strictures are to be defined or how to judge the costs for individual companies, much less specific industries, particularly with uncer- tainties as to the future of environmental regulation under current and future administrations. Very little research has been done in this area, and without facts, overreaction is found to be the rule.
In the arcane world of economic influences upon company analysis, the burden is on management—and by extension, the investor relations practi- tioner—to clarify, to explain, to define context. For example, when the price of the dollar on world markets changed abruptly a few years ago, it made it seem that companies with large overseas operations were losing revenues and profits. But given an understanding of foreign currency trans- lations, those companies with better investor relations communications and marketing skills fared better in the stock market than did other companies in the same plight. More recently, when the dollar was falling against the Euro, U.S. companies raced to do more business overseas and that message has helped the stocks of Coke, McDonald’s, Caterpillarand others perform better in the stock market.