classifying industries

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CLASSIFYING INDUSTRIESThe Standard Industrial Classification (SIC) system was the basis for the collection and > analysis of [lie U.S. economy for more than 60 years. The SIC system, could be used to put i together a comprehensive Statistical analysis of an industry. Developed in the 1930s when manufacturing dominated the U.S. economy, ibis sysiem'was revised many times because of rapid changes in our economy, particularly the expansion of services. SIC codes aided significantly in bringing order [o the industry classification problem by providing a consistent basis for describing industries and companies. Analysis using 51C codes could focus on economic activity in as broad, or as specific, a manner ds desired. Nevertheless i the SIC system was criticized for not being able Co handle rapid changes tn the U.S. economy. This led to the development of the North American Industry Classi&-cation System (NAICS), which replaced the SIC codes in 1997. -

A NEW CLASSIFICATION SYSTEMNAICS ".The North American Industry Classification System (NAIC5) is a significant change for analyzing economic activities. It was developed using a production-oriented conceptual . framework; therefore, companies are classified into industries based on .the activity in which they are primarily engaged. Basically, companies that do similar things in similar ways are classified together. NAICS uses psuf-digit hierarchical coding system to classify ail economic activity into 20 industry sectors, which provides greater llexioihty relative to SK, coaes- rilteen 'ql these sectors are de vole d to services-producing sectors compared to five sectors thai' are mainly goods-producing sectdis...NAICS allows for the identification of 1,170 industries. Ninc.new service sectors and 250 new service industries are recognized. . , '. Using NAIC5 codes, the Plasiics Product Manufacturing industry is coded 3261. Within [his code number aie several breakdowns, including among others, Plastic Pipe and Pipe Filling Manuiacturiri)i (326122), and Plastics Bottle Manufacturing (3261CO): . \ , ^

OTHER INDUSTRY CLASSIFICATIONS -

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Thi: SIC system of indusiry cl.i.ssifi cation has pmbably been the most consistent system availahk. As noted, NAICS L> a new classification sysiem providing more detail- However, in the Investments field several well-known invesimeni advisory companies have developed their own industry groupings. For example. Standard &r Poor's Corporation

provided weekly siock indexes on ll..'>ector5 and approximately 115-Indus try groups for a long lime. These weekly indexes have often been used to assess an industry's performance over time. As of March 2002. SfaP has been using a new system known as the Global Industry Class ilication Standard (G1CS) 10 provide "one complete, continuous set of global sector and industry dcfmiLions." This system divides everything into 10 "economic sectors": Consumer Discretionary, Consumer Staples, Energy. Financials, Healili Care, Industrials. Irifonnaiion Technology, Materials, Telecommunications Services, and Utiliiies, Within this framework there are 24 indu5try groupings, 64 industries, and 139 subindustries (as 01 April 2005), Tliis system is intunded to classify companies around the world and already includes 25,000-1- companies. Peer groups arc denned tightly. S&P's GICS system, developed Jointly with Morgan Stanley Capital International, provides considerably mote ('n ^il lii.i;! 'i&P's pfcvious classifii-.aiiun system. This ill tum will pcnnil users lo more icadily 1 customize porifolios and indexesriie Value Lilif: Invesimciit 5w-'c.y f.uws roughly 1,700 comp"nie^, divided imu approximately 96 inUu-'iirics, with a discussion of industry p)'.,pccts prcccdine ill-'

3CT CHAPTER 14

SECTOR/INDUSTRYANALYSIS

company analysis. These Industry, classifies lions can be quite useful to Investors because Value Line ranks their expected performance (relatively) for ihe year anead, Other providers of information use different numbers of industries In presenting data. The important point 10 remember If that multiple industry classification systems are used.

The Importance Analysfs_______

of

Sector/Industry

WHY INDUSTRY ANALYSIS IS IMPORTANT OVER THE LONG RUN Sector and industry analysis is important to investor success because over the long run very significant differences occur in the performance of industries and major economic sectors of the economy. To see this, we Mil examine the performance of Industry groups over long periods of time using price indexes foe industries. Standard & Poor's has calculated weekly and monthly stock price indexes foe a variety of industries, with data available fora 50-year-plus period. Since the data are reponed as index numbers, long-term comparisons of price performance can be made tor any Industry covered. Note that the base number for these'S&P data is 1941-1943 = lO.there--fore, dividing the index number for any industry for a particular year by 10 indicates the number of limes ihe index has increased over lhai period. The top part of Table 14-1 shows the long-term price performance of randomly selected industries for the years 1973. 1983,1995. and March 2000 (when the stock market peaked after five consecutive years of strong-performance). The S&rP 500 Composite Index In 1973 was almost 10 times (98/10) its 1941-1943. level, a continuouslyTable 14.-1 Foor'i Weekly Using Data Standard & for Various Yeari. Stock All with a Bur 19T1 AutamobJIei fl Aluminum 90 Btvefl(M 113 BwlrigM (Sofc '! (Alcoholic) EItLiriul 2BO Drink)) Enitrtilnmnt M Equlpmini fOCKJl S9 Hultl- Cire IIB S&P SOU Index W (Drugl) 1M1-43 =10 \m Broadcasc en Media Price of Indexel IMi-43 1941-19 1983 43 100 IBS W IS7 522 W w ' w I&S 1986 1309 for = 10 Selecte 3 10 d 1!M 134 393 W 1343 17W 2431 1037 2313 616 1789 Indunrit ' 200(1* 508 703 717 m 605 7071 1312 52*3 1W itts law. W7 30MI

Entcrtilnment Heilth Cara Money Center (Di-ugi) ftttall SinksSiorci SAP iOO Indax Campoilt*

307 1 65 104 141

577 S 66 IS9 241

IJ83 94?1 11 375 3S3

2431 7073 2223 SM 4t> 233 321 W 61 tW

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Checking Your UnderlCiinduiJ 361 compounded average in excess of 8 percent annually over this 31-year period. By March 2000, the index wa;> about 150 times its base. However, this average growth rate For the index as a whole consisted cf widely varying perlonnance over the various industries covered by Standard & Poor's. Over the 30-year period 1943-1973, the electrical equipment industry did well, rising to 28 times ihc base number, while the eniertainment industry was only 3.4 limes the base. By 1983, the alcoholic beverages industry was only eight limes its original base, while electrical equipment was 52 times higher. An examination of the entire time period, 1941-1943 through March 2000 shows that the entertainment industry increased more than 700'fold whili: the electrical equipment industry did almost as well at about 650 times the base. Meanwhile, the auto industry was only about 50 times the base. Notice the dramatic diHereuce in die Alcoholic Beverages industry and thf.' Soft Drink Beverages industry over the-period ending in both 1995 pnd March 2000. The lower half of Table 14-1 shows selected and matched Standard &i Four's Industry Stock Price indexes for ihe years 1982. 1986. 1989. 1995. and March 2000 Chased on 1941-1943 = 10). Therefore, Table 14-1 provides both a 58-year-plus picture of industry performance (from 1941 to 1943), which approximates the maximum investing lifetime of many individuals, and a look at how much change can occur tn shorter periods of nmr. such as three (1986-1989), four (1982-1986), seven (1982-1989). thirteen (19B2-1995). and roughly eighteen (1982-2000) years. Tremepdous differences existed for industries in the 1980s and between periods in the 1960s and 2000. Notice how Money Center Banks did nothing between 1982 and 1986, but then almost doubled and redoubled through 199S, and almost redoubled again by March 2000. Broadcast Media performed in an incredibly strong manner over the enure period from 1982 to 1995, but the change troca 1995 to March 2000 is astounding. ^Reta.l Stores, having declined from 1989 to 1995. almost tripled from 1995 to March 2000. The lesson to be learned from Table 14-1 is simple. / ^ Industry analysis pays because industries perform very differently over longer periods of time and investor performance will be significandy affected by the particular industries thai investors hold in their portfolios. Investors are seeking to identify the Broadcast Media and Health Care (Drugs) industries of the future, and avoid the Money Center Banks and Retail Stores industries of the future.

1. How important is industry analysis to investors? 2. What has been the major change in the U.S. economy in the Ias[30 or tOyeau as far as industries are concerned? ,' .-" -- '

INDUSTRY PERFORMANCE OVER SHORTER PERIODSWhat about shorter periods of time and recent data) Docs the same prind,p'ie hold true that industries perform very differently? Let's consider S&iP's niiw GIC5 classification system and analyze-a five-year period cndinr in November 2.005. As noted previi.'usly, there arc 10 broad sectors in this nuw clas.'iidcario" system, and these are shown in Table 14-2 along with two indusiries in the IntonmiLiun Technology sci-tur. The ba^e tor ihcsc in; wS&cP. Industry class! fica Huns

382 CHAPTER14 SECTOR/1NDUSTRYANALYSIS Table l'5-l PerformaneeofSectoriintilndusiriesUsingS& P's GSIC CliSiificationSy stem. Djta end November 1005_______ ___________________________Annual Rate ofChanga Consumr Dlicit