It is always preferable to do extensive research and collect the comprehensive data of a company before buying any particular stock. Industry analysis is one way to secure your investment money in some company’s stock. In order to do that, you have to choose the right industry to invest in, read case studies and reports filled up with empirical data and information which tells the relation of the company with the current stock market.
But, even you know that it is still not enough. No matter, how much data you go through or choose the company which is performing really well in the current market, we still need some model or anything which can strategically analyze the business of the company and used for analyzing our investments.
Luckily, we have something even better. And by something better means, “Porter’s Five Forces.”
It is a framework originated by Michael E. Porter of Harvard University which first published in Harvard Business Review in the year 1979.
So, what exactly Porter’s Five Forces use for?
Let’s break it down.
Porter’s 5 Forces
Porter’s 5 Forces is a simple yet powerful tool that analyzes the competitiveness of any business environment. You can use this tool to analyze the business not only in stocks sector but any business industry. According to Porter, industry growth rates and technical innovations are temporary factors. To understand a business clearly, you must go to the source and fundamentally analyze a company’s stance in its respective industry.
This is why Porter’s 5 forces are the key sources or you can say competitive forces that shape every industry. So, instead of focusing on fleeting factors, it would be wise to understand these five forces which will help in determining the position of a company in its industry.
These five competitive forces are as follows –
- Industry rivalry
- The threat of substitutes
- The threat of new entrants
- The bargaining power of buyers
- The bargaining power of suppliers
- Let’s take a look at each one of them one-by-one.
This one concerns about your rivalry in the industry and checks for the no. of competitors you have in your segment. Because, more the competitors you have with almost equivalent products and services, less the power you have in the market.
Almost every industry is facing the threat of competitors. It would be wise to analyze the sort of threat that company is facing where you are planning to invest in. In doing so, you can check for brand equity, brand position, innovations, and current status in the stock market.
Stating the obvious but customers used to switch the product or sometimes brand when they get product from the competitor at a better value. Sometimes, customers tend to switch companies when they are not satisfied with the current services.
So, make sure you analyze the competitiveness of the company you are thinking to invest in, it is because, if the company loses customers to their competitors then it would lose business in the future eventually. If that happens, it can affect your ownership with the stocks.
The Threat of Substitutes
In here, the threat of substitutes used for products or services. Like above, if people are not satisfied with the services, they may switch to alternative brand or product. It indicates the behavioral pattern of customers; if any changes happen in it then it would hinder the performance of a company.
For example, you are planning to buy stocks of a motor vehicle company as a long-term investment, but what if the prices of petrol and diesel rise in the not too distant future. The result, customers plan to commute with bicycles or public transports. If that happens, it will defiantly affect the performance of the company which automatically affects yours.
The Threat of New Entrants
The threat of new entrants is a very crucial component in the list of Porter’s 5 competitive forces. It is obvious new entrants will enter the market by passing the multiple barriers, if they are to compete with long-established companies.
If there are no barriers to entry in the market then any company can enter the market replicate the model of the firm which has established and doing business for a long time. These barriers to entry help well-established companies to maintain their market returns. Any threat of new entrant may decrease the returns.
So, don’t forget to check for the government and natural barriers to entry before you put your hard-earned money on some big company’s stock who is seeing the margin, returns, and share price declines as an entrant enters the industry.
The Bargaining Power of Buyers
The bargaining power of buyers or customers specially deals with the ability of buyers to drive prices down. This force affected by the no. of buyers or customers a company holds and how important each customer is. The company’s position and power are directly proportional to the quality of client base.
The Bargaining Power of Suppliers
As it is implying, this force is about the power suppliers holds to drive the prices of services and goods. If a company has less no. of suppliers then it would hold the company back to switch from one to another. The result, the company will be more dependable on the suppliers and suppliers will hold more power.
Final Thoughts: –
Investors who are planning to do long-term investments should give more weighage to qualitative measures like Porter’s Five Forces rather than quantitative measures such as debt/equity ratio and price/earnings.
Although many investors primary concern is quantitative measures but to invest for the future, you can’t just rely on the current share market facts and the position a company holds at present. You need to go deep and understand its business. Only then you will be able to take the smart decision of investing in the right industry.
If you have any query or would like to add something then don’t forget to mention in the comment section below.