In a previous article, I discussed the use of the SWOT analysis and how it can assist us in our investing research on a company. In this article, I will talk about using a framework called PEST to further analyse aspects of a company which the SWOT method may not have covered.
PEST stands for “Political, Economic, Social and Technological,” and the aim is to cover these four important aspects surrounding a company to get a better sense of where the company stands. Let’s dive into each aspect below. [Editor’s note: An article discussing the Porter’s Five Forces model has been published. It can be found here.]
The questions to ask here would be: What are the political influences or factors which may boost the company, or break the company? In other words, is the company’s business very sensitive to political decisions, and does its continued prosperity depend a lot on government contracts or in having close ties with the government? This is a pertinent factor because if there is a change in government, it could very well change the investment thesis for that company.
A recent example would be the shock change in government for Malaysia. Most of the companies which had close ties and contracts with the previous government saw their share prices fall sharply when the election news broke out.
Economic factors would not just refer to the state of the economy in general, but also the demand and supply situation within the industry which the company operates in. We should study the economic metrics and factors which have a bearing on the company’s business. An example would be the consumer price index (CPI), which is a good indicator of spending habits and inflation. If the CPI is high, there is less propensity to spend and this may adversely affect companies in the discretionary consumer retail industry.
Other economic factors may include (but are not limited to) the growth in supply and demand on a year-on-year basis for a particular product or service; the average price increases of competitors’ products in relation to the company’s; currency exchange rates; and the interest rates being charged by banks on corporate loans.
Social factors looks at the demographics of the population, and their attitudes towards health, child-bearing, and their career, to name a few. Population growth rates would be linked to birth rates, and these are important when considering industries which supply, say, baby formula milk or diapers. Health attitudes are used to assess if a population has a tendency to spend on healthcare, and would influence sectors such as medical tourism, for instance.
The proportion of smokers would also be a factor to consider in terms of healthcare needs as more money needs to be spent on smoking-related illnesses in countries with a higher percentage of smokers. Demographics include an ageing population, which may mean a labour supply crunch as the proportion of working adults is reduced over time.
Technology factors include the presence of automation, research and development activity, and also the rate of technological change. The pace of change would affect industries which produce parts for machines or equipment, while the presence of automation may mean higher efficiency and cost savings in many industries.
Most importantly, technological shifts and advancements would lead to innovation, which may create new industries or render existing ones obsolete.
Foolish bottom line
As can be seen above, a PEST analysis is indeed a very useful tool for the investor to use, in addition to the SWOT analysis.
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