Does Industry-Level Analysis Improve Profitability and Growth Forecasts?

Abstract

A long history of economic theory suggests that industry membership plays an important role in explaining a firm's financial performance. In this paper we investigate the usefulness of industry benchmarks and industry level analysis for predicting a firm's future profitability and growth. Specifically we investigate whether incorporating the industry performance metric provides incremental information over the firm specific metric for explaining performance one-year-ahead. We also investigate the usefulness of performing industry level analysis relative to an analysis of all firms pooled across the economy. We find little or no incremental explanatory power from incorporating industry information for predicting future profitability, defined either as return on equity or return on net operating assets. Nor do we find industry information incrementally informative for predicting growth in net operating assets. We do, however, find significant improvement from incorporating industry information for predicting growth in sales. These general results hold for one-, three-, and five-year windows, and are robust to alternative industry classification schemes.