Business Valuation
Apr 8, 2023
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This guide explains what PESTEL analysis is, and why its a useful tool for analyzing a business. Here are some key takeaways about PESTEL analysis:
More generally, PESTEL analysis is used to identify the pros and cons of a target company's strategy.
In mergers and acquisitions, PESTEL analysis is used as a framework to assess risks and opportunities in order to inform investment decisions.
Financial analysis is quantitative in nature, and strategic analysis is qualitative in nature. We use qualitative analysis such as PESTEL in order to build the assumptions and drivers that flow into various financial models.
Through this, we are able to build more accurate models that are grounded in realistic scenarios.
As mentioned above, PESTEL is an acronym for political, economic, technological, environmental, and legal.
Next, we'll look at each of these factors so that you can see how these will impact the external environment the business operates within.
Political factors can certainly have a large impact on both industries and the individual companies operating within them.
To begin with, we have government policies that are fiscal in nature like taxation and government spending.
Corporate tax rates are big considerations for both investors and management teams alike. Government/business relations are another consideration that analysts need to pay close attention to, particularly during election periods. These relations impact government initiatives as well as government funding and the grants that flow to the industry.
Governments are also responsible for regulation surrounding competition and antitrust issues. Views on competition and antitrust are often influenced by political initiatives.
Finally, global trade is impacted by political factors as well. Risks to supply chains, prices, and tariffs will impact trade.
Economic factors are more quantitative in nature than political factors are and, as a result, they are normally more straightforward to model.
Here, we'll look at some of the economic factors that will influence strategic analysis.
First, monetary policy gives us important drivers when building financial models. One of the most important is inflation.
Inflation is a driver in most financial models. It directly impacts our assumptions about how material costs will rise in the near future.
Inflation is always a concern. If the money supply is increased for an extended period of time, it can have a negative effect on the economy. This prompts increased interest rates, which will also impact financial statements.
Typically monetary policy is administered by the central bank of the respective country, and is designed to help control the money supply. We'll look at a few examples of monetary policy here.
As an example, overnight lending rates are an element of monetary policy that impacts corporate finance. They are used by central banks to help manage inflation. These overnight lending rates will influence the cost of borrowing and they will impact bond yields as well. This influence, in turn, affects both how assets are allocated in the capital markets as well as consumer and business spending.
Monetary policy also has a direct impact on foreign exchange rates, due to the inflows and outflows of capital.
Additionally, central banks (like the US Federal Reserve) can purchase or sell US treasury bonds. If they buy treasuries, it injects money into the economy. This is called quantitative easing and it tends to have the effect of increasing consumer spending and investment activity. These factors influence business in the respective country.
We also need to take into consideration employment rates and the economic cycle stage we are projecting from.
Social factors have a large impact on our analysis as well.
To begin with consumer beliefs and values change over time.
As an example, we've seen a shift towards healthier lifestyle choices. This has impacted the types of foods that consumers want to eat, packaging materials, how nutritional information is presented, and the transparency surrounding ingredients and sourcing.
Trends like these should be considered during the decision making process.
In addition to consumer beliefs and values, demographic trends influence our analysis as well.
As an example, smaller average family sizes and a migration towards urban areas has impacted real estate development as well as the nature of how business is done.
As another example, we've seen an increase in the demand for mobile shopping, food service delivery apps, on-demand video streaming, online dating, and for faster package delivery times.
Technological factors are also important to take into consideration.
Technology can help or hinder industries, and it can completely disrupt them.
An example of this is artificial intelligence. This technology is expected to disrupt many industries and it is expected to help others grow exponentially.
Often, when analyzing a business its R&D spend will be compared to an industry peer group. This is especially the case when analyzing large companies or businesses in the technology sector. R&D spending is more important in some industries than others, but it can influence projections and the market's perception of a business versus it's competitors.
Additionally, access to the internet is a driving growth factor in some instances. As more and more markets gain access to high-speed internet and smart phones, demand in many industries is influenced.
Cyber security threats are an additional consideration. Consider Tiktok and its legal issues with the US government. Many of these concerns are over cybersecurity threats that have certainly impacted the companies future prospects.
Technological development can also have the effect of reducing headcount and administrative costs for businesses, as well as economic and unemployment challenges for communities.
Initially PESTEL analysis was just PEST analysis. Over time the environmental and legal factors were added to the framework because of their obvious influence over the external business climate.
Environmental factors include climate change, carbon footprints, impacts on supply chains, and the ESG framework.
Clear disclosure and management surrounding environmental concerns is becoming increasingly important for management teams as this can impact consumer perception of the brand.
Legal factors also represent opportunities and risks that can impact business operations.
Pending litigation, labor standards, intellectual property rights, and the industry requirements around licensing and permits are important things to consider.
As an example, industry requirements around permits or licenses may be seen by investors as a valuable barrier to entry to the industry. These barriers to entry tend to cut down on competition.
Warren Buffet famously called this concept an "economic moat." An example of this is the banking industry. There are large barriers to entry, namely starting a bank would require enormous amounts of capital as well as the ability to navigate the heavily regulated industry.
Additionally, potential changes to reporting standards can impact businesses as well.
