The first three analysis tools dealt with abstract numbers such as earnings forecasts and P/E ratios and the like without regard to the company’s business. Given the same numbers, your conclusions would have been identical whether you were analyzing a maker of chewing gum, buggy whips, guided missiles, or computer chips. Now it’s time to learn about your candidate’s business, its industry, and its competition.

The Business

Your first step is to determine what the company does, that is, the products and services that it sells. That’s a no-brainer if you’re talking about Wal-Mart, but how many investors know what Lucent Technology or Network Appliance do for a living?

Surprisingly, few investing sites do a good job of providing that information. One that does, however, is Multex Investor. Its Company Overview page offers a concise but readable paragraph describing a company’s products and services.

Multex’s Business Description page goes into more depth than the overview, describing each of the company’s major products and services, probably in more detail than you’ll want to know at this stage of your research, but you’ll need it later.

Morningstar also offers a concise company overview on its Snapshot page, which is different, although not necessarily better than Multex’s. I suggest reading both to gain a better understanding of the company’s business.

Morningstar also offers a longer review, written by a Morningstar analyst, for many, but not all stocks. The review gives you the analysts’ take on the company’s business plan, and on its competitive position. Morningstar’s analyst review is concise, doesn't go into much depth, and you must be a paid subscriber to see it. Still, it’s a worthwhile read, usually giving you a better perspective on the company’s operations than you’d otherwise have. It’s worth paying the $12 or so monthly fee.

Industry Growth Outlook

Once you understand a company’s line of business, your next step is to research its industry, starting with growth prospects. Why? If you’re a growth investor, you want growing companies, and you’ll find them mostly in growing industries. Otherwise, your picks will have to grow earnings by cutting costs, by taking market share from competitors, or by acquiring other industry players. Although many firms have successfully practiced these strategies, they are inherently riskier than participating in a growth industry.

The competition is less intense in a fast-growing market because there is plenty of business for all contenders. As an industry matures, and growth slows, companies change their focus to increasing market share. That usually translates to price-cutting, which leads to eroding margins and reduced earnings.

Value investors, although satisfied with a slower pace than growth investors, should still be concerned about their candidate’s industry growth prospects. It’s tough, even for value investors, to make money holding companies that are battling to survive in a declining industry. Industry growth means sales growth, but industry sales growth forecasts are hard to find. However, analysts consensus earnings growth forecasts are readily available for most industries. So we’ll start with industry earnings growth forecasts, and then convert the earnings growth numbers to sales growth.

Analysts’ Forecasts Are Good Enough

Why would you want to rely on analysts’ forecasts when few trust their buy/sell ratings?

For starters, although analysts may have conflicted interests, most try to come up with accurate earnings growth forecasts. The industry growth forecasts are compiled from consensus long-term earnings growth forecasts for all the companies making up each industry. Since the industry forecasts are the average of many individual forecasts, they are probably more accurate than the individual company forecasts. Secondly, predicting long-term growth is easier said than done, and despite their failings, analysts’ forecasts are probably as good as anyone’s. Besides, you need ballpark figures, not precise estimates. Despite their other shortcomings, analysts’ growth forecasts are good enough for this purpose.

MSN Money’s Earnings Estimates page is a good place to find the industry earnings growth forecasts. I’ll use network storage device maker Network Appliance to demonstrate the process. MSN Money reported analysts consensus 5-year average annual growth forecasts of 24 percent for Network Appliance and 21 percent for its industry, computer storage devices.

Convert Earnings Growth to Sales Growth

Once you have the industry forecast, you can convert the earnings growth forecast to sales growth. By analyzing historical data, I’ve found that on average, long-term industry earnings growth typically outruns sales growth by 15 percent or so. Also, analysts’ long-term forecasts usually run high, probably by 10 percent to 15 percent.

Taking those two factors, together, I figure that discounting long-term earnings forecasts by 30 percent is a reasonable rule of thumb for estimating industry sales growth. Sure, this method is based on all kinds of assumptions, but so are everybody’s forecasts. In reality, it’s all guesswork, and this technique is probably as close as anyone’s. Applying the 30 percent discount factor, I estimated 15 percent annual sales growth for computer storage, Network Appliance’s industry. Is 15 percent good or bad? It depends.

The moderate 10 percent to 15 percent growth range is a favorite for many value investors, because to them, 15 percent is high, and they think it’s unrealistic to expect more. Moderate growth industries are suitable for growth investors, but only if they can pinpoint firms growing faster than their peers.

Growth investors generally need faster growth than value investors and find their best prospects in industries growing between 15 percent and 25 percent annually. The best performing companies in these industries could score 30 percent to 50 percent, or even higher annual sales gains. Value investors, although unbelievers, may still find beaten up value candidates left for dead by the growth crowd after the company tripped up.

Look at high industry growth forecasts skeptically, since analysts sometimes get carried away. That’s especially true when an industry is experiencing super-heated growth, such as the telecommunications industry saw in the late-1990s. Here are five industries considered by many analysts as having the best long-term growth prospects.

Financial Services

Health Care

Entertainment Products

Consumer products for a healthy lifestyle

Technology