13.4.1 Classifying Industries By Product Or Service

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):

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.