Archives for December 2010

Analyzing Sectors-Part 2

When investing, it is important that you learn analyzing different sectors. In the previous article, we looked at some factors that you should look for in general in all companies. Now, we will look at specific sectors and how to analyze them. We begin by looking at the utilities sector.

Analyzing Utilities Sector

Over the years the Utility industry has changed a lot. Earlier, this industry was considered safe but now, following large scale regulatory changes, demand generation, price volatility, and increase in competition-the industry has changed. Few years back we saw only few behemoths monopolies controlling the industry. However, with deregulation there has been a dramatic change in the industry. But the changes are different from country to country. For example, high deregulation in the US has seen many private players entering the industry. But in Brazil, electricity production and distribution is dominated by state owned companies.

Brazil is the 10th largest energy consumer in the world. In South America Brazil is the largest energy consumer. Rapid economic development and surge in Brazilian exports meant that government had to frame regulatory policy in a way that pushed energy production, increased foreign investments in energy sector, and increased competition. Government has also taken several measures to improve energy efficiency both in industrial and residential sector.

Oil: Brazil is the 15th largest oil producer in the world.  Petrobras a state owned company with an estimated output of 2 million barrels a day is the major distributor of oil in the country. Deregulation has meant that there are about 50 companies that are exploring oil opportunities in Brazil.

Electricity: The major power company in Brazil is Eletobras. Eletrobras alone covers about 60% of electricity demand in Brazil. In order to meet the growing demand of electricity due to economic expansion, the government framed new regulatory framework in 2004 that encouraged competition thereby increasing productivity and production.

Hydropower: Brazil is the third largest hydroelectricity producer after China and Canada.

Bio fuels: Brazil is rich in natural resources. It is world’s biggest producer of sugarcane crop. Ethanol fuel is produced from sugarcane. As a result it is also an important source of energy to Brazil. By 2015 it is estimated that production and consumption of biodiesel will be 5% of diesel fuel.

In this article, we have given you a basic structure of the utilities industry. Generally, the utilities sector is seen as recession proof i.e. it can survive a downturn in the economy better than most other sectors. However, on the flipside, the sector will lag behind when there is an upward trend in the economy.

Note – If you want our team to write articles like these for you, please get in touch with us. Email Shas at indogeniclegal[at]gmail.com and we will respond within 24 hours.
If you want our team to write articles like these for you, please get in touch with us. Email Shas at indogeniclegal[at]gmail.com and we will respond within 24 hours.

Analyzing Sectors-Part 1

Introduction and the Porter % forces analysis

Imagine if you are new investor looking for investing opportunities in stocks. However, you are a knowledgeable investor and you know virtues of diversifying your portfolio. So, you decide that you will invest in stocks from different industries. You analyze all industries and evaluate them with same benchmarks. Chances are that you will lose out rather than make any money. Benchmarking different industries on same valuation techniques is like comparing apples with oranges. That is, comparing P/E ratio of a technology company with a utility company or comparing the cash flow statement of a steel Company with cash flow statement of a software manufacturing company.

Hence, it is imperative for investors to know how to evaluate different industries, different sectors using various tools. We will learn how to do investment analysis by focusing on a particular industry or sector

Applying the Porter 5 forces analysis

This model was developed by Michel E. Porter in 1980 in his book called the “Competitive Analysis: Techniques to Analyze Industries and Competitors.” According to this book, there are five important forces that shape industry and completion in the market. These 5 forces help us in evaluating everything that affects the business through competition, to the attractiveness and profitability of the business.

The following are the Porter 5 forces to analyze any industry

Threat of new entrants: Accordingly, competition in an industry depends upon how easy is it to get in that industry. If the barriers to enter a particular industry are big then those who are already in the industry will enjoy no intensity in the competition. Conversely, if there are no barriers to enter the industry, competition among industrial players will be huge.

Industries which are capital intensive or those industries where high level of technological innovations or research and developments are required are relatively difficult industries to enter.

Power of suppliers: This reflects how much pressure suppliers can exert on the market or business. Raw materials, semi-finished products, and components are often commodities supplied by small companies to large manufacturing companies; their suppliers usually lack bargaining power. Conversely, the suppliers of complex, technically sophisticated components may be able to exert considerable bargaining power.

Power of buyers: It reflects how much pressure customers can place on the market or business deciding the margins and prices of goods or services. The strength of buying power that firms face from their customers depends on two sets of factors: buyers’ price sensitivity and relative bargaining power.

Availability of substitutes:
It reflects how likely is it that someone in the market will switch to a product or service provided by the competition/substitutes in the industry. For instance, if the price of coffee shoots up people will start drinking tea.

Degree of rivalry among competitors: For most industries, the major determinant of the overall state of competition and the general level of profitability is competition among the firms within the industry. In some industry firms compete aggressively-sometimes to the extent that prices are pushed below the level of costs and industry-wide losses are incurred.

Note – If you want our team to write articles like these for you, please get in touch with us. Email Shas at indogeniclegal[at]gmail.com and we will respond within 24 hours.
If you want our team to write articles like these for you, please get in touch with us. Email Shas at indogeniclegal[at]gmail.com and we will respond within 24 hours.

Understanding commodity price indices

Significance: Commodities are unprocessed or semi-processed raw materials used for food or in the manufacture of other goods. Commodity prices in general are important lead indicators of cost pressures. Prices of metals and, to lesser extent, non food agricultural are also indicative of the level of demand in the industrialized countries and emerging economies.

Price instability and influencing factors on price:  commodities may be divided into three broad groups depending on whether their prices are influenced mainly by demand, supply, or both.

Demand: The prices of industrial raw materials, such as metals and minerals, fluctuate in response to changes in demand, reflecting mainly economic conditions in the industrialized countries and major emerging economies like Brazil, Russia, China and India. Recession brings lower demand and weaker prices. Supply tends to be more stable and predictable.

Supply: Food prices are influenced most heavily by unplanned changes in the supply side. For example, world vegetable oil prices depend significantly on the effects of weather on the countries harvesting soya beans crops and policies of those countries on stockpiles.

Index composition: Creating an ideal commodity price index is intellectually testing because :

o Commodities are not comparable- 1 ton of coffee is quite different from 1 ton of copper.
o They are difficult to value-for example, only 2.5% of rice production is traded on international markets; and
o Relative prices are distorted by large fluctuations in individual commodity prices.

Despite these problems there are many indices combining the prices of several commodities.  The most widely followed indices are prepared by IMF, the UN, the World Bank, the American Commodity Research Bureau (CRB) and the Economist commodity price index.

The basket weights: Whereas the Economist index is designed to measure cost pressures in industrial countries; its constituents are weighted according to their share on OECD imports. The UN, IMF and World Bank indicators are intended to monitor the terms of trade in developing countries; the constituents are weighted to reflect shares in developing countries’ exports. The CRB index just gives equal weight to all commodities, which understates the importance of industrial commodities and so makes it less useful as a leading indicator of inflation.

Note – If you want our team to write articles like these for you, please get in touch with us. Email Shas at indogeniclegal[at]gmail.com and we will respond within 24 hours.
If you want our team to write articles like these for you, please get in touch with us. Email Shas at indogeniclegal[at]gmail.com and we will respond within 24 hours.

Types of Options

An option could have almost anything as an underlying so long as the underlying actively trades on a market where the current price is available on a continued basis. In this article, we will take a look at some the different types of options.

Equity Options

An equity option gives the owner the right to buy or sell a certain number of common shares (in most countries 100 is the standard number) in a particular company. An equity option is not issued by the company on whose shares the options are being traded and it does not receive any money from the issuance. If the option is exercised, the owner will end up acquiring or selling the underlying shares. Equity options are a cheaper way to speculate on price of the underlying shares going up or down.

Index Options

An index option is based on an index of prices in some market other than options. Stock market indexes are most popular; however, the underlying could even be a bond index or a commodity index. There are options traded on almost all major stock market indexes as well as on the Goldman Sachs Commodity Index and the Baltic Freight Index of ship charter rates. Each option is based on the index times a multiple.

Interest-Rate Options

There are two types of Interest-Rate Options;

Bond Options; Bond options are based on the price of government bonds.

Yield Options; Yield Options are based on the interest rate paid by a bond.

Interest rate options allow investors to speculate on interest rate movements without purchasing the actual bonds.

Commodity Options

Commodity options, along with Equity Options, are one of the most popular types of option. The underlying for these types of options could be any type of commodity so long as it is traded on a continued basis.

NOTE : If you want our team to write articles like these for you, please get in touch with us. Email Shas at indogeniclegal[at]gmail.com and we will respond within 24 hours.