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Subject 2. Industry Classification PDF Download

The first step is to define the boundaries of the industry in question and its constituents. Industries are commonly defined as companies that sell similar products or services.

Third-Party Industry Classification Schemes

The structures of these systems are very similar. Commercial industry classification systems include:

  • The Global Industry Classification Standard (GICS) is an industry taxonomy for use by the global financial community. It is used as a basis for S&P and MSCI financial market indexes in which each company is assigned to a sub-industry and to a corresponding industry, industry group, and sector, according to the definition of its principal business activity.

  • The Russell Global Sectors classification system uses a three-tier structure to classify global companies based on the products or services they offer.

  • The TRBC by Refinitiv system provides a standardized framework for categorizing companies and industries based on their primary business activities.

The limitation of current classification systems is that the narrowest classification unit assigned to a company generally cannot be assumed to constitute its peer group for the purpose of detailed fundamental comparisons or valuation. Companies can sell diverse products or services across many industries and products similarity is subjective. Geographical considerations and changes in groupings over time are 2 other limitations.

Alternative Methods of Grouping Companies

There are a few main approaches to classifying companies:

  • Products and/or service supplied. This is the main approach to industry classification. Companies are categorized based on the products and/or services they offer. The term "sector" is used to refer to a group of related industries. Discussed above.

  • Business-cycle sensitivities. A cyclical industry is sensitive to business cycles. Its revenues are generally higher in periods of economic prosperity and lower in periods of economic downturn. The performance of a non-cyclical industry is independent of the business cycle.

    Non-cyclical industries can be sorted into two categories:

    • A defensive (or stable) industry demonstrates stable performance during both economic expansion and contraction.

    • Companies in a growth industry achieve above-normal growth rates and profitability at any stage of the general business cycle.

    However, there are limitations when using these industry descriptors. For example, some industries may include both growth companies and defensive companies. A global company can experience economic expansion in one part of the world while experiencing recession in another part.

  • Statistical similarities. Statistical cluster analysis is defined as the art of finding groups in data such that the degree of natural association is high among members within the same class (internal cohesion) and low between members of different categories (external isolation). This technique can be used to categorize companies into different industries.

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