13.4.1 Classifying Industries By Product Or Service

Detailed guide on classifying industries by product or service, using the Global Industry Classification Standard (GICS) as defined by Standard & Poor’s (S&P) and Morgan Stanley Capital International (MSCI).

Overview

A natural and intuitive way to classify an industry is by the product or service it produces. For instance, the automobile industry comprises companies that manufacture cars. Investment dealers commonly use this classification system to define the coverage universe of their equity analysts.

Well-known providers of equity indexes, such as Standard & Poor’s (S&P) and Morgan Stanley Capital International (MSCI), have developed a comprehensive industry and sector classification system called the Global Industry Classification Standard (GICS). Each company within their indexes is assigned to one of 158 sub-industries. These sub-industries are aggregated into 69 industries, which are further grouped into 24 industry groups and ultimately collated into 11 sectors.

GICS Structure

The following table lists the 11 sectors along with their 24 associated industry groups based on the Global Industry Classification Standard (GICS):

Sector Industry Groups
Communication Services Telecommunication Services, Media and Entertainment
Consumer Discretionary Automobiles and Components, Consumer Durables and Apparel, Consumer Services, Retailing
Consumer Staples Food and Staples Retailing, Food, Beverage, and Tobacco, Household and Personal Products
Energy Energy
Financials Banks, Diversified Financials, Insurance
Health Care Health Care Equipment and Services, Pharmaceuticals, Biotechnology, and Life Sciences
Industrials Capital Goods, Commercial and Professional Services, Transportation
Information Technology Software and Services, Technology Hardware and Equipment, Semiconductors and Semiconductor Equipment
Materials Materials
Real Estate Real Estate
Utilities Utilities

Source: “Global Industry Classification Standard (GICS)”, MSCI, www.msci.com/gics.

Challenges in Classification

Multi-Industry Operations

One significant challenge in classifying industries by products or services occurs when companies operate in multiple industries. For example, before Canadian Pacific Limited was divided into several entities, its revenue sources included hotels, shipping, and railways. This diversification made it complex for analysts to compare Canadian Pacific Limited to other companies or accurately assess its growth potential. Diversified companies require detailed segmentation analysis.

Single-Industry Operations

Conversely, companies operating solely within one industry, like Barrick Gold Corporation, are more straightforward to classify. Barrick Gold is easily identified as a gold producer. Thus, its classification provides clear insights into its market behavior and potential.

Key Takeaways

  • GICS Structure: The GICS system offers a thorough framework to classify companies based on their products and services into sub-industries, industries, industry groups, and sectors.
  • Complexity in Multi-Industry Businesses: Organizations with diversified revenue streams pose challenges in classification, necessitating a nuanced analysis approach.
  • Simplicity in Single-Industry Businesses: Companies restricted to one industry, such as Barrick Gold, are easier to analyze and categorize.

Frequently Asked Questions (FAQs)

Q1: What is GICS?

A1: The Global Industry Classification Standard (GICS) is an industry taxonomy developed by S&P and MSCI to classify each company into 158 sub-industries, aggregated into 69 industries, 24 industry groups, and 11 sectors.

Q2: What are the benefits of using the GICS classification?

A2: GICS offers a detailed and organized framework that helps in comparing companies within the same industry, identifying investment opportunities, and conducting financial analysis.

Q3: Why is it more challenging to classify companies with multi-industry operations?

A3: Multi-industry companies have revenue streams originating from various sectors, making direct comparisons and growth potential assessments more complex.

Glossary

  • GICS: Global Industry Classification Standard, a taxonomy system for classifying industries, developed by S&P and MSCI.
  • Sub-industry: The most granular level of industry classification representing specific niches within a broader industry.
  • Industry Group: A collection of industries grouped together within the broader sector classification.
  • Sector: The broadest classification level in the GICS system, encompassing related industries.

Diagrams

    graph LR
	  A[Sectors] -->|Comprise| B[Industry Groups]
	  B --> |Aggregates| C[Industries]
	  C --> |Encompasses| D[Sub-Industries]

Diagram 1: Hierarchical classification from Sectors to Sub-Industries in the GICS structure.

Conclusion

Classifying industries by the product or service they provide is an effective means to organize and analyze companies. The GICS system is an indispensable tool for investors and analysts, offering an exhaustive and structured framework to navigate the multifaceted landscape of industry classification.


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## What is a common method to classify an industry? - [ ] By geographic location - [ ] By company size - [x] By the product or service it produces - [ ] By the stock market it is listed on > **Explanation:** Classifying an industry by the product or service it produces is a natural and common method. For example, the automobile industry includes companies that manufacture cars. ## What is the name of the comprehensive industry and sector classification system developed by S&P and MSCI? - [ ] North American Industry Classification System (NAICS) - [ ] Standard Industry Classification (SIC) - [x] Global Industry Classification Standard (GICS) - [ ] International Industry Classification System (IICS) > **Explanation:** The Global Industry Classification Standard (GICS) is a comprehensive industry and sector classification system developed by S&P and MSCI. ## How many sectors and industry groups are defined by the GICS system? - [ ] 24 sectors and 11 industry groups - [ ] 11 sectors and 69 industry groups - [x] 11 sectors and 24 industry groups - [ ] 24 sectors and 69 industry groups > **Explanation:** The GICS system defines 11 sectors and 24 industry groups. ## Into how many sub-industries do S&P and MSCI assign every company within their indexes? - [ ] 69 sub-industries - [ ] 24 sub-industries - [ ] 11 sub-industries - [x] 158 sub-industries > **Explanation:** S&P and MSCI assign each company within their indexes to one of 158 sub-industries. ## Which of the following sectors is grouped under the Communication Services industry group in GICS? - [x] Telecommunication Services - [ ] Automobiles and Components - [ ] Consumer Durables and Apparel - [ ] Real Estate > **Explanation:** The Communication Services sector in GICS includes the Telecommunication Services industry group. ## Which industry group under the Consumer Staples sector includes companies involved in food and beverage? - [ ] Food and Staples Retailing - [x] Food, Beverage, and Tobacco - [ ] Retailing - [ ] Consumer Services > **Explanation:** The Food, Beverage, and Tobacco industry group under the Consumer Staples sector includes companies involved in food and beverage. ## In which sector of the GICS would you classify pharmaceutical companies? - [x] Health Care - [ ] Energy - [ ] Financials - [ ] Materials > **Explanation:** Pharmaceutical companies are classified under the Health Care sector in GICS. ## Which classification challenge is noted for companies like the former Canadian Pacific Limited? - [ ] Lack of available industry data - [ ] Too much financial transparency - [x] Operation in more than one industry - [ ] Foreign ownership issues > **Explanation:** Companies like the former Canadian Pacific Limited faced the classification challenge of operating in more than one industry, making it difficult for analysts to compare and evaluate them. ## Why does classifying Barrick Gold Corporation have relevance? - [ ] It operates in multiple industries - [x] It operates solely in one industry - [ ] It is globally diversified - [ ] It has been recently restructured > **Explanation:** Classifying Barrick Gold Corporation has relevance because it operates solely in the gold industry, providing clarity for analysis. ## How many industry groups are associated with the Financials sector in GICS? - [ ] One - [ ] Two - [x] Three - [ ] Four > **Explanation:** The Financials sector in GICS has three associated industry groups: Banks, Diversified Financials, and Insurance.

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Tuesday, July 23, 2024