DEFINITION of Industry Life Cycle Analysis
Industry life cycle analysis is part of fundamental analysis of a company involving the examination of the stage an industry is in at a given point in time. There are four stages in an industry life cycle: expansion, peak, contraction, trough. An analyst will determine where a company sits in the cycle and use this information to project future financial performance and estimate forward valuations (e.g., forward price-earnings ratios).
BREAKING DOWN Industry Life Cycle Analysis
Though not necessarily the case, the life cycle of a particular industry will follow the general economic cycle. Moreover, an industry life cycle may lead or lag an economic cycle, and can vary from an economic cycle's phases in terms of expansion or contraction percentages or duration of peak and trough stages. During an expansion phase in open and competitive markets, an industry will experience revenue and profit growth, drawing in more competitors to meet the growing demand for that industry's goods or services. The peak occurs when growth drops to zero; demand in the cycle has been met and prevailing economic conditions do not encourage additional purchases. Industry profits flatten out.
The contraction phase of the life cycle begins at some point after the peak arrives, characterized by falling profits as current period sales are lower relative to prior period sales (when demand was on the rise). The contraction phase could be concomitant with a recession in the economy or merely a reflection that short-term demand in the industry has been exhausted. During the contraction phase, the industry undergoes production capacity adjustments, whereby marginal players get shaken out and stronger companies lower their production volumes. Industry profits decrease.
This adjustment process, combined with a firming of the economy observed in employment and personal income numbers and the consumer confidence index, lead to the trough phase of the industry life cycle. At this stage, lower levels of industry demand are matched by the output capacity. As the economy gathers strength, the industry life cycle begins again with the expansion phase. As mentioned at the outset, an industry life cycle is typically tied to the economic cycle. The entertainment and leisure industry is an example of such an industry. The technology industry, on the other hand, has exhibited life cycle movements at variance with the economic cycle. For instance, industry profits have boomed even in times of no economic growth.