Why analyze an industry, and the steps to do it
Industry and competitive analysis gives a valuation its context: it supports the model's inputs and a narrative consistent with them. It runs in five steps: define the firm's industry, survey it (size, growth, profitability), evaluate its structure with Porter's Five Forces, assess outside influences with PESTLE, then evaluate the firm's competitive strategy.
Before this: Scenario analysis with probability weights, The Firm and Market Structures
On the exam
- Describe the process of industry and competitive analysis
Describe the process of industry and competitive analysis. Expect: put the five steps in order, name the step a task belongs to (estimating industry size, rating the threat of entry, judging a new regulation), and say why analysts do the work: to support valuation inputs and a consistent narrative.
How deeply to learn each part
- Know the idea
- Understand it in general. It frames other topics, but you will not calculate with it.
- Use it
- Understand it well enough to solve a question with it. Recognize when it applies.
- Memorize
- Learn it by heart. The exam will not give it to you.
You know this one. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still do.
You tested strong here. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still know it.
Why look at the industry before the company?
Companies in the same industry sell similar products to similar customers, buy from similar suppliers, hire similar workers and face the same shocks. Think of a cement producer and its rivals: they all depend on construction activity, energy prices and the same few quarries. Because they share the same demand and supply conditions, the structure of the industry explains much of the long-run difference in profitability between one industry and another.
Industry and competitive analysis studies what drives an industry’s size, growth, profitability and market shares, and where a company stands within it. It comes after the valuation tools of the earlier Equities modules for a reason: discounted cash flow, multiples and forecast models produce numbers, and those numbers need a story about the business that makes them believable. Firms offering similar goods or services to the same customers tend to share the same opportunities, threats and value drivers, so the industry is the natural place to start.
Why does a valuation need industry analysis?
Use it
Two reasons. It supports the numerical inputs in a valuation model, and it builds a valuation narrative that is consistent with those inputs.
A forecast that the company grows sales 9% a year is only believable if the industry can grow that fast, or if the company can keep taking share. A margin forecast is only believable if the industry’s structure lets someone earn it. Industry analysis is where those checks happen.
The work is iterative. What you learn about the industry changes the model, and the model shows which industry questions matter most. The finished narrative goes into the research report next to the numbers.
Exam tip If a question asks why an analyst studies the industry before valuing a company, look for ‘support the model’s inputs’ and ‘a consistent narrative’. Finding the cheapest share is not the purpose.
What are the steps?
Five steps, from the industry down to the firm. The first four look at the industry; the last looks at the company.
- Define a firm’s industry . Decide which companies sell comparable products or services to the same customers. Third-party classification schemes such as the Global Industry Classification Standard (GICS), the Industry Classification Benchmark (ICB) and the Refinitiv Business Classification (TRBC) are the usual starting point.
- Run the industry survey . Gather data on its size, growth and profitability (operating margin, or return on invested capital (ROIC) against the weighted average cost of capital (WACC)), and on which firms make it up, how their market shares are moving and how concentrated the industry is, measured with the Herfindahl-Hirschman Index (HHI).
- Evaluate the industry structure with Porter’s Five Forces: the threat of new entrants, the threat of substitutes, the bargaining power of suppliers and of customers, and rivalry among existing competitors. The forces explain how profitable the industry is and suggest how its structure might change.
- Assess external influences with PESTLE (political, economic, social, technological, legal and environmental influences). These explain the industry’s growth rate and shifts in market share.
- Carry out the competitive analysis , which evaluates the firm’s competitive strategy and position. This step is specific to the company and is the subject of Learning Module 10, Company Analysis.
- 1. Define the firm's industry Memorize classification schemes as a start
- 2. Survey the industry Memorize size, growth, profitability, market shares
- Size top-down or bottom-up
- Growth compared with the economy
- Profitability operating margin or ROIC against WACC
- Market shares and concentration
-
- 3. Evaluate industry structure Memorize Porter's Five Forces, so profitability
- 4. Assess external influences Memorize PESTLE, so growth and market share
- 5. Evaluate competitive strategy Memorize firm-specific: Learning Module 10
- 1What happened: the facts.
- 2Why: profitability inside, growth from outside.
- 3Findings change the model; the model shows what to check.
The next four lessons cover steps 1 to 4: classification, the survey, the five forces with economic moats, and PESTLE with the innovation matrix.
Go deeper Why the order matters
Structure and external influences explain what the survey found: the survey says margins are thin, Five Forces says why. Judging the firm last means its strategy is measured against a defined, surveyed industry and not against a vague idea of ‘the market’.
Memorize this
MemorizeThe five steps, in order
| Step | Question it answers | Tool |
|---|---|---|
| 1. Define the industry | Who are the comparable firms? | GICS, ICB, TRBC, judgment |
| 2. Survey | How big, how fast, how profitable, who has the share? | size, growth, operating margin, ROIC against WACC, market shares, HHI |
| 3. Structure | Why is the industry as profitable as it is? | Porter's Five Forces |
| 4. External influences | What drives its growth and share shifts? | PESTLE |
| 5. Competitive analysis | Can this firm do better than its industry? | firm-specific analysis (Learning Module 10) |
Memory hook Classify, survey, structure, outside, firm: from the industry in to the company.
Know it cold Five Forces explain profitability; PESTLE explains the growth rate. The firm comes last, never first.
MemorizeWhy do it
| Purpose | What it means |
|---|---|
| Support the inputs | growth, margins and risk in the model have an industry reason |
| Build the narrative | a story about the business consistent with those numbers |
| Iterate | what the analysis finds changes the model, and the reverse |
Memory hook Numbers plus a story that fits them.
Know it cold Industry analysis does not replace the valuation model; it supports it.
- 1. Define the firm's industry Memorize classification schemes as a start
- 2. Survey the industry Memorize size, growth, profitability, market shares
- Size top-down or bottom-up
- Growth compared with the economy
- Profitability operating margin or ROIC against WACC
- Market shares and concentration
-
- 3. Evaluate industry structure Memorize Porter's Five Forces, so profitability
- 4. Assess external influences Memorize PESTLE, so growth and market share
- 5. Evaluate competitive strategy Memorize firm-specific: Learning Module 10
How it is asked
-
Put the steps in order
Which is the first step of industry and competitive analysis?
Define the firm's industry. Five Forces is step 3 and the firm's strategy is step 5. Starting with the company is the trap.
-
Which step is this?
An analyst estimates an industry's total sales and its growth over ten years.
Survey the industry. Rating the forces is structure; outside drivers are PESTLE.
-
Why do it?
What is the main purpose of industry and competitive analysis in equity valuation?
Support the model's inputs and a consistent valuation narrative. Picking the cheapest share is not it.
-
Which framework, which question?
Which framework explains an industry's growth rate?
PESTLE. Five Forces explain profitability.
Exam traps
- Putting the firm's competitive strategy before the industry survey. The company is judged against a defined and surveyed industry, so it comes last.
- Using Five Forces to explain growth or PESTLE to explain profitability.
- Treating industry analysis as a separate exercise from valuation. Its job is to support the model's inputs and the narrative.
Checkpoint
3 exam-style questions. About 90 seconds each.
1Which is the first step of industry and competitive analysis?
2An analyst studies how an aging population and a planned tax on sugary drinks could change demand for a beverage industry's products. Within industry and competitive analysis, this work is best described as:
3The main purpose of industry and competitive analysis in equity valuation is best described as:
Key takeaways
- Industry and competitive analysis supports a valuation's inputs and gives it a consistent narrative.
- Five steps: define the industry, survey it, evaluate structure (Five Forces), assess external influences (PESTLE), evaluate the firm's competitive strategy.
- Five Forces explain profitability; PESTLE explains growth and market share shifts.
- The work is iterative: the analysis and the model refine each other.
All Equities formulas, every lesson
Practice exam-style questions on Industry and Competitive Analysis
Questions about this lesson?
Where this comes back
- Industry classification: GICS, ICB, TRBC and other groupings Industry and Competitive Analysis
- Competitive strategy: cost leadership, differentiation and focus Company Analysis
Questions candidates ask
Why is industry analysis important in equity valuation?
It supports the inputs of the valuation model, such as growth and margins, and gives the valuation a narrative consistent with those numbers. Firms selling similar products to the same customers share opportunities, threats and value drivers.
What are the steps of industry and competitive analysis in CFA Level 1?
Define the firm's industry, survey its size, growth and profitability, evaluate its structure with Porter's Five Forces, assess external influences with PESTLE, then evaluate the firm's competitive strategy.
What is the difference between Five Forces and PESTLE?
Five Forces look at competition inside the industry and explain its profitability. PESTLE looks at outside influences and explains its growth rate and shifts in market share.
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