Industry groups

What Are Industry Groups?

Industry groups are a fundamental component of financial classification systems, serving to categorize companies that share similar business activities, products, or services. These groupings provide a structured framework for investors and analysts to understand market dynamics, assess performance, and conduct in-depth economic analysis. They represent an intermediate level within hierarchical classification systems, sitting below broad sectors and above more granular industries or sub-industries. Grouping companies into industry groups facilitates comparative investment research and can help identify trends across related businesses.

History and Origin

The concept of classifying businesses into logical groups emerged to bring order to vast and diverse economic data. In the United States, one of the earliest standardized systems was the Standard Industrial Classification (SIC) system, established in 1937 by the U.S. government. Its purpose was to standardize industry classification for statistical purposes across various agencies, using a four-digit code to categorize industries. The SIC system was last revised in 1987.

In 1997, the North American Industry Classification System (NAICS) was adopted by the U.S., Canada, and Mexico to replace the SIC system, aiming for greater comparability in business statistics among the three countries and a more production-oriented classification²¹, ²². NAICS classifies establishments based on the similarity of the processes used to produce goods or services²⁰. While NAICS largely superseded SIC for statistical purposes, some U.S. government departments and agencies, such as the U.S. Securities and Exchange Commission (SEC), continue to use SIC codes for certain filings¹⁹.

In the financial investment community, the Global Industry Classification Standard (GICS) was developed in 1999 by MSCI and S&P Dow Jones Indices. GICS was designed to provide a universal, reliable, and flexible tool for investment professionals, offering a four-tiered structure that includes sectors, industry groups, industries, and sub-industries¹⁷, ¹⁸. This system is widely accepted globally for classifying securities by industry¹⁶.

Key Takeaways

• Industry groups categorize companies with similar business operations, products, or services.
• They form an intermediate level in hierarchical classification systems, such as GICS and NAICS.
• These groupings are crucial for market analysis, portfolio management, and performance benchmarking.
• Key systems include GICS (Global Industry Classification Standard) for financial markets and NAICS (North American Industry Classification System) for government statistical purposes.
• Understanding industry groups aids in identifying trends, assessing competitive advantage, and making informed investment decisions.

Interpreting Industry Groups

Industry groups provide a lens through which to interpret aggregated financial data and understand concentrated risks or opportunities. When analyzing an industry group, investors often examine collective trends in earnings reports, revenue growth, profitability, and capital expenditures. This aggregation helps in identifying shifts in consumer demand, technological advancements affecting a group of businesses, or regulatory changes impacting a specific segment of the economy.

For example, an analysis of the "Semiconductors & Semiconductor Equipment" industry group within the GICS framework would involve examining the collective performance of companies involved in chip manufacturing and related equipment. Such an analysis can reveal insights into the broader technology sector's health or the global supply chain dynamics influencing electronics production. Interpreting industry group performance helps investors gauge the impact of macroeconomic factors or market cycles on a collection of businesses, rather than just individual companies.

Hypothetical Example

Consider an investor, Sarah, who is performing due diligence on an electric vehicle (EV) manufacturing company. Instead of evaluating this company in isolation, Sarah decides to analyze its relevant industry group. Under a hypothetical classification system, EV manufacturing might fall under an "Automotive & Electric Vehicles" industry group, which is part of a broader "Consumer Discretionary" sector.

Sarah would examine other companies within this "Automotive & Electric Vehicles" industry group. She collects data on their collective sales growth, profit margins, research and development spending, and market capitalization. She observes that while the individual EV company she is considering has strong sales, the broader industry group is facing increasing raw material costs and intense competition, leading to declining collective profit margins. This indicates potential headwinds for the entire industry group, suggesting that even a strong individual company might face profitability challenges. This industry group perspective provides Sarah with a more comprehensive understanding of the competitive landscape and inherent risks beyond just the single company's financials.

Practical Applications

Industry groups are widely applied across various facets of finance and economics. They are instrumental in sector investing strategies, where investors allocate capital based on the expected performance of specific industry segments. For instance, an investor might overweight the "Healthcare Providers & Services" industry group if they anticipate demographic shifts or policy changes favoring that segment.

In financial reporting and economic data analysis, government bodies and statistical agencies use systems like NAICS to collect and publish data, which aids in macroeconomic policy formulation and business planning. The U.S. Census Bureau, for example, utilizes NAICS to classify business establishments for collecting, analyzing, and publishing statistical data related to the U.S. business economy, enabling comparability across North America¹⁴, ¹⁵. This structured classification also helps companies benchmark their performance against industry peers, identify potential customers, or analyze competition. Financial professionals utilize industry groups for benchmarking portfolio performance against relevant industry-specific indexes. Furthermore, understanding industry groups can inform decisions related to capital allocation and resource deployment within large corporations.

Limitations and Criticisms

Despite their utility, industry classification systems and industry groups have limitations. A primary challenge arises with multi-product companies or those with diverse business models that span multiple industries. Assigning such a company to a single industry group may not fully capture the totality of its exposures, benefits, and risks¹², ¹³. For example, a large technology conglomerate might operate in cloud computing, e-commerce, and entertainment, making it difficult to precisely categorize its primary business activity within a single industry group¹¹.

Another criticism is that these systems may not always reflect rapid technological advancements or evolving business models, leading to potential misclassifications or outdated groupings¹⁰. Annual reviews are conducted by classification system providers (like MSCI and S&P for GICS) to adapt to market changes, but a lag can still exist⁸, ⁹. Relying solely on industry group classifications without additional due diligence can lead to suboptimal diversification or investment decisions if the classification does not adequately represent a company's true revenue drivers and risk profile⁷. It is essential for investors to conduct their own analysis to circumvent these limitations.

Industry Groups vs. Industry Sectors

The terms "industry groups" and "industry sectors" are often used interchangeably, but within many formal financial classification systems, they represent distinct hierarchical levels. An industry sector is a broad classification that encompasses a wide range of companies operating in related general areas of the economy. For example, "Technology" or "Financials" are common industry sectors.

Industry groups, on the other hand, are a more granular classification level within a sector. They group companies that are more closely related in terms of their primary business activities, products, or services than those simply sharing a broad sector classification. For instance, within the "Technology" sector, one might find industry groups such as "Software & Services," "Semiconductors & Semiconductor Equipment," or "Technology Hardware & Equipment." Similarly, the "Financials" sector might contain industry groups like "Banks," "Capital Markets," and "Insurance." This distinction allows for a more refined analysis of industries and their corresponding asset classes and facilitates targeted risk management.

FAQs

How are industry groups determined?

Industry groups are typically determined by hierarchical classification systems that analyze a company's primary revenue sources, products, and services. For example, GICS assigns companies based on their principal business activity⁵, ⁶.

Why are industry groups important for investors?

Industry groups help investors understand how different segments of the economy are performing, facilitate comparative analysis between companies with similar operations, and aid in constructing diversified portfolios. They are key for portfolio management and sector-specific strategies.

What is the difference between an industry group and an industry?

An industry group is a broader category that contains several related industries. For example, within the "Technology Hardware & Equipment" industry group, you might find specific industries like "Computers & Peripherals" or "Electronic Equipment & Instruments."

Are industry classifications static?

No, industry classifications are not static. Systems like GICS undergo annual reviews to ensure they accurately reflect the evolving global markets and changes in business models³, ⁴. New industries emerge, and existing ones may merge or decline, necessitating updates to classification structures.

What are some common industry classification systems?

The most common systems include the Global Industry Classification Standard (GICS), the North American Industry Classification System (NAICS), and the Standard Industrial Classification (SIC) system. GICS is widely used in finance, while NAICS is prevalent for government statistical purposes¹, ².