Using Porter's 5 Forces to Analyze Stocks
In order to properly examine the balance sheet for indicators of strength, weakness or potential fraud, the financial documents must be studied as a whole. Adjustments in accounting policies, modifications to operations and historical balance sheet comparisons all provide vital quantitative measures to assess the financial strength of a company. While numerical figures such as ratios and revenue forecasts are undoubtedly vital to the investment decisions, qualitative analysis offers another useful tool.
Porter's Five Forces
Porter's five-force framework is a qualitative tool that applies to investment analysis. The framework helps analyze a firm's competitive stance in its industry. Porter's forces examine industry-specific conditions and help investors determine how well a corporation is positioned to adapt to changes in its target market.
Michael Porter's analysis serves as an alternative to Albert Humphrey's more common SWOT (strengths, weaknesses, opportunities, threats) model.
Porter's five forces are:
The threat of substitute services or products
The threat of increased competition from rivals in the market
The threat of new entrants into the market
The bargaining power of suppliers
The bargaining power of customers
Using these forces requires a solid understanding of the general industry/market, corporate business model and an appreciation for how the business can adapt to changes in market conditions. Basically, investors must analyze how a company can respond to the underlying threats. For example, it's common for a company to rank high in terms of competitive resistance on four forces and fail horribly on the fifth. Inevitably, determining how such a scenario would affect an investment's appeal is up to the investor.
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