Evaluate Industry Performance to Determine Stock Value

By Michael Taillard

Each industry responds differently and at different times to different variables. Understanding how each sector responds to cycles and policies in economy is very important for traders and investors alike.

For example, during a recession corporations that work in consumer staples (soups, soaps, cereals, and so forth) tend to see a boost in stock prices because demand for these things doesn’t decrease greatly. People will give up other, more discretionary goods in order to get the things they need.

This is particularly true for corporations that offer cheap or discount consumer staples, such as Dollar Tree. As a result, you can begin to develop an understanding for how strongly each sector responds to changes in the economic cycle. When gross domestic product (GDP) growth slows, you can measure how much sector growth slows.

Another thing to consider is the timing of the response within the sector to changes in the economy. This happens because of the order of cash flows throughout the national economy.

An injection of cash into the agricultural sector, for example, will very likely go next to agricultural supply corporations, such as Monsanto, because farms and farmers tend to spend a large proportion of their revenues on the products these corporations produce.

After you understand how cash flows through the economy, you can begin to estimate the timing that each sector will experience based on where the initial change in cash flows begins. This phenomenon is called sector rotation.

After you establish the relationship between a sector and other sectors in the economy, you can start to evaluate the sector itself. Here are some questions to ask when assessing a sector:

  • How many competitors are there?

  • What makes the successful firms more competitive?

  • What are the risks of new entrants or new technologies shaking things up?

  • How is the industry as a whole changing over time?

  • How is it doing compared to other industries?