What is Industry Analysis?

Fundamental analysis can ensure you invest in good quality companies for long-term wealth creation. One of the most important aspects that most investors miss out on when fundamentally analysing a company is the industry to which it belongs. 

Industry analysis can provide valuable insights to help you better understand a company and its business environment. In this article, we will look at the meaning of industry analysis, its importance, and the different types of industry analysis methods that most successful investors follow.

Industry Analysis Meaning

Industry analysis is a process that involves quantitatively and qualitatively evaluating the industry in which a company is operating. It is a key component of fundamental analysis and focuses on multiple aspects of an industry such as its overall health, regulatory landscape, performance metrics, current trends, and future growth potential.

Industry analysis helps identify underperforming and overperforming industries, including those poised for growth or attaining stability. In addition to potential investors, analysis of industries is also routinely carried out by governments, companies, and market analysts. 

Also Read More About Fundamental Analysis Tools in Share Market

Importance of Industry Analysis 

Understanding the importance of industry analysis is crucial for making informed decisions. Here is a quick overview of some compelling reasons why you should analyse the industry before investing.

• Helps Identify Risks 

By analysing an industry, you can better identify the various risks associated with investing in it. Knowing the risks before investing allows you to take measures to counteract them. These measures could be anything from avoiding overexposure to volatile industries to portfolio diversification.     

• Unearths Growth Opportunities

Industry analysis allows you to spot sectors with high growth potential. This can lead you to invest in industries with strong growth potential and the ability to outperform the broader market.

• Provides Context to a Company’s Performance 

Merely assessing a company’s financial metrics may not always give you an accurate picture. To get the entire context of its performance, you must analyse the industry in which it operates.  For instance, a company’s performance might look impressive in isolation, but understanding its industry position can reveal whether it is outperforming its peers or not.

• Gives Insights into Market Movements 

The economy and industries move in cycles. As an investor, it is important to understand these cycles since they enable you to anticipate future market trends and adjust your investment strategy accordingly. Industry analysis can provide in-depth insights into the market movements and cycles of the chosen industry.   

• Helps Assess the Impact of Regulations 

Industries in India face varying levels of regulation. Industry analysis can help you understand these regulations and their impact on the company. Additionally, it can show how changes in the regulatory landscape could potentially affect the company.     

Types of Industry Analysis 

The industry analysis methods investors, companies, and market analysts use can be categorised into multiple types. Let us look at some of the most popular types of industry analysis techniques.

• Porter’s Five Forces

Conceptualised by Micheal E Porter, Porter’s Five Forces is among the most popular industry analysis methods that are currently in use. As the name implies, the model considers five key aspects, which are as follows: 

• The threat of new entrants
• The bargaining power of suppliers
• The bargaining power of buyers
• The threat of substitute products or services
• The rivalry among existing competitors

By thoroughly evaluating these components, you can assess the competitive intensity, attractiveness, and profitability potential of any industry.   

• SWOT Analysis 

Another of the most commonly used types of industry analysis methods is the SWOT analysis. SWOT is an acronym that stands for Strengths, Weaknesses, Opportunities, and Threats. Investors who use this analysis framework evaluate the industry and its companies based on the above-mentioned four components to determine the overall health and profitability.  

• PEST Analysis 

Although not as popular as the other two industry analysis methods, large institutions and analysts use the PEST analysis framework to understand the macro-environmental factors affecting an industry. The components of this industrial analysis method include the following: 

• Political factors
• Economic factors
• Social factors
• Technological factors

Some investors and analysts use a variant of this method. Termed PESTEL analysis, this technique includes two new components in addition to the four mentioned above. These include environmental factors and legal factors.      

Industry Analysis Example

Here is a hypothetical example involving a nascent and fast-growing industry to help you understand the true meaning of industrial analysis.

For this industry analysis example, we will take up the electric vehicle (EV) industry, to which we will apply the SWOT analysis technique. On initial analysis, you identify the following strengths, weaknesses, opportunities, and threats that this industry faces.  

• Strengths

The electric vehicle industry has been gaining significant attention from all directions primarily due to the following strengths.

• Environmental benefits: Electric vehicles contribute to the environment by not producing any harmful emissions like traditional fossil-fuel-powered vehicles.
• Lower operating costs: Electric vehicles, irrespective of the segment, generally have lower operating and maintenance costs. 
• Technological innovation: The EV industry is at the forefront of innovation, with significant advancements in battery efficiency, range, autonomous driving capabilities, and other automotive technologies.   
• Government backing: The EV industry, especially that of India, has traditionally received strong support from the government through various subsidies, incentives, and legal regulations.  

• Weaknesses

On analysing the industry more deeply, we can observe a few weaknesses that the industry has to overcome in the future. These include the following: 

• Higher initial costs: Despite low operating and maintenance costs, EVs are still out of reach of many potential buyers due to their higher upfront costs.   
• Range limitations: A major weakness of the EV industry is the limited driving range of vehicles, which is a key concern for buyers.  
• Limited charging infrastructure: The charging infrastructure in India is still developing. The sparse charging infrastructure is a huge barrier to adoption. 
• Battery production challenges: The EV industry, as a whole, is facing challenges in securing raw materials, which limits battery production and acts as a growth constraint.   

• Opportunities

The electric vehicle industry’s growth opportunities are immense. If leveraged carefully, the sector can grow by leaps and bounds. Some of the opportunities include: 

• Rising demand: The demand for EVs is rising rapidly across the globe, with projections of significant growth over the next decade.  
• Expansion into new segments: The EV industry has the opportunity to expand beyond personal vehicles and into commercial vehicles, trucks, and public transportation. 
• Integration with renewable energy: There is significant potential for synergy between EVs and renewable energy systems, which can create new business models and opportunities.

• Threats

The EV industry is constantly under threat by different factors and segments of the economy. Here is a quick overview of some of the key threats. 

• Hybrid vehicles: Hybrid vehicles are the most immediate threat to the industry. Rising demand for these vehicles could dent the adoption rate of EVs.  
• Regulatory changes: Major changes in regulations, government policies, or incentives could negatively impact the industry’s growth.
• Economic factors: Economic downturns or changes in consumer spending patterns could affect EV sales.
• Raw material supply: Disruption in raw material supply in terms of price or material shortage can significantly impact the industry.  

As you can see in this industry analysis example, the SWOT analysis framework provides a snapshot of the EV industry as it is currently. However, it is important to remember that the conditions and situations may change over time. As an investor, you must ensure that you perform industry analysis at regular intervals to keep yourself updated with the various changes. 

Conclusion 

Industry analysis is an important tool that can help you identify potential investment opportunities. It can also prevent you from investing in underperforming industries or those with limited growth potential. That being said, it is important to remember that industry analysis methods can only give you a broad overview of the industry as a whole. To make well-informed investment decisions, you must pair it with individual company analysis.

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