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Qualitatively Analyzing the Industry

When investing, it’s crucial to consider each industry’s customer base, industry-wide growth, regulation and business cycles. For instance, if an industry isn’t growing, a company will have to steal market share in order to grow. Furthermore, if an industry is declining, perhaps due to better technology elsewhere, then even more caution is necessary.

Competition within the industry is another factor to consider. Industries that have limited barriers to entry and a large number of competing companies create a very difficult operating environment that significantly hurt margins. If investing in a company with high-end products, competitors with lower-priced products should be analyzed for their competitive advantages and disadvantages. As an investor, your chief goal is to find a company with sustainable rapid growth. Remember, it’s ok to end up investing in an entirely different company than the one you originally began analyzing.

Because of the importance or severity of their products and/or services, certain industries are heavily regulated by the government. Although these regulations are important to the public, they can dramatically affect company’s attractiveness to investors. For instance, in industries where one or two companies represent the entire industry for a region (such as utility companies), governments usually dictate how much profit each company can make. Even though there is still potential for sizable profits, they are limited because of regulation.

In other industries, regulation can play a less direct role in affecting industry pricing but can determine the success or failure of a company. The drug industry is a perfect example. The U.S. Food and Drug Administration (FDA) requires that new drugs must pass a series of clinical trials before they can be sold and distributed to the general public. However, the result of all this testing is that it usually takes several years and millions of dollars before a drug is approved, that is “IF” it is approved.

Bottom line, investors should keep all these things in mind when assessing the risks and rewards of investing in a particular company or industry.