Fundamental Analysis of a company involves a lot of criteria to be considered before investing. As a priority, understanding the industry landscape is essential, as it provides an extensive outlook into the factors that can affect the performance of the industry, an in turn, shed light on the specific impact on a particular company.
There are many established frameworks for that purpose, which include:
(i) Michael Porter’s Five Force Model
(ii) PESTLE analysis
(iii) BCG Matrix
(iv) SCP analysis
Under Micheal Porter's five force model, the criteria are divided into:
1. Threat of Substitutes
2. Threat of New Entrants
3. Threat of Established Rivals
1. Bargaining Power of Suppliers
2. Bargaining Power of Customers
Understanding the various forces provides a better clarity on the positioning of the company.
PESTLE Analysis: Stands for Political, Economic, Socio-cultural, Technological, Legal and Environmental Analysis. Some models also extend this to include Ethics and Demographics, thus modifying the acronym to STEEPLED. This analysis is done more from the perspective of a business which is looking to setup international operations, and analyzing several countries to choose from the available options. This model primarily analyses the external environmental factors that will act as influencers for a business.
BCG Analysis: While models such as Porter’s and PESTLE are used to analyze the industries and economies, the Boston Consulting Group (BCG) Analysis looks at different segments of a business unit at portfolio basis, from the view of of market growth and cash generation.
As per the matrix, business segments can be classified as:
Stars: These are segments in a business where market is growing rapidly and company is having a large market share. This segment generates increasing cash for the business with the passage of time.
Cash Cows: These are segments which require low cash infusion for investment to maintain market share of a particular product portfolio, because of low growth prospects, but at the same time, steadily generate cash for the company from the established market share.
Question Marks: Business segments in a fast growing market, but having low market share. The right strategies and investments can help the market share of the business grow, but they also run the risk of consuming cash in the process of increasing market share, and in the end can turn out to be not enough cash generating for the company.
Dogs: Business segments, which have slow growth rates and intensive competitive dynamics which lead to low generation of cash are categorized as Dogs.
Structure Conduct Performance (SCP) Analysis: SCP Analysis is a method of analyzing industries, which looks at the industry structure (monopoly, oligopoly), its conduct (commoditized or specialized, seasonal or round the year, cyclical or noncyclical etc.) and finally its performance (RoE, RoIC, WACC, etc.).
Understanding the industry before a company analysis provides in-depth working of that particular sector, which helps in analyzing the companies better, with established criteria from a quantitative and qualitative perspective.