Posted in Finance, Accounting and Economics Terms, Total Reads: 501
Groups of companies that carry out similar primary activities that make up the largest source of revenue, can be classified into industries. Industry analysis provides a framework for understanding a firm and its business environment including the potential growth, competition, risks, debt levels, etc for a firm. An active management strategy can use industry valuation in determining optimal industry weights in a portfolio.
Firms can be grouped into industries on the basis of the primary products produced, services provided, business cycle sensitivity or via statistical methods. Commercial classification of industries available to investors is generally categorized on the basis of sector, followed by the industry and sub-industry levels. On this basis, firms are classified into basic materials and processing, consumer discretionary, consumer staples, energy, financial services, health care, industrial and producer durables, technology, telecommunication and utilities firms. The S&P’s and MSCI Barra provide an industry classification system called the Global Industry Classification Standard. Government agencies also set industry classification standards such as the International Standard Industrial Classification (ISIC).
Cyclical industries include firms whose earnings are highly dependent on the business cycle stage. Non-cyclical industries can further be classified as defensive and growth industries on the basis of the consumption pattern for goods and services. For example, consumer staples and utilities are defensive industries with a stable demand for goods produced. Growth industries have strong demand for the goods produced that is independent of the business cycle. Porter’s five forces provides a framework for firms to determine the industry competition. Understanding the impact of demographic, governmental, social and technological influences on the industry growth, profitability and risk is an important component of industry analysis. These frameworks help a firm to decide on the competitive strategy that firms can adopt within an industry such as cost-leadership or differentiation strategy.