CFA Level II Equity has two new readings for 2014. No readings have been replaced, so the whole three-study session topic has got a little longer.

CFA Level II, Reading 33: Your Strategy Needs a Strategy

This short reading analyses industries on two dimensions:

• Predictability (to what extent the industry’s future can be foreseen accurately), and
• Malleability (to what extent one organization can change the industry).

Industries are then described in a 2×2 matrix of high/low predictability and malleability, with strategies being adaptive, classical, shaping, or visionary. (Can you put these into the four boxes?

CFA Level II, Reading 34: Industry and Company Analysis

Despite the title, which may indicate that the reading will be somewhat word-based, this chapter is all about financial modelling (sorry, financial modeling). We break down financial statements into income statement, balance sheet and cash flow statement, and consider each component.

Many of the income statement values can be analysed using a top-down approach (e.g. relative to GDP growth, inflation, or other economic indicators) or a bottom-up approach (e.g. looking at revenues or costs by product line or geographic region), or a hybrid combination of the two. Segmental analysis is invaluable in identifying which products or regions are growing and which are shrinking, generating higher (or lower) revenues and costs. We also try to identify economies of scale through cost analysis. Interest and tax expenses are also considered.

On the balance sheet, different approaches should be used for working capital and property, plant & equipment (PP&E), with return on invested capital (ROIC) giving a strong indication of competitive advantage.

We revisit Michael Porter’s five forces analysis (which makes a star appearance in an earlier reading as well) of an industry’s competitiveness, and in particular the strength of a company’s pricing power. If industry forces are weak, pricing power is strong.

Inflation and deflation are considered on both revenues and costs, technological developments are discussed, and issues relating to long-term forecasting are mentioned. The reading concludes with a full worked example going through the steps in creating a financial model.