Industry Classification Systems

Industry classification attempts to place companies into groups based on commonalities. There are three major approaches to industry classification.

Current Industry Classification Systems

Commercial Industry Classification Systems

• Global Industry Classification Standard: developed by Standard & Poor’s and MSCI Barra. Each company is assigned to a sub-industry according to its principal business activity. Comprised of 154 sub-industries, 68 industries, 24 industry groups, and 10 sectors.
• Russel Global Sectors: based on the products or services a company produces. Comprised of 141 industries, 32 subsectors, and 9 sectors.
• Industry Classification Benchmark: jointly developed by Dow Jones and FTSE. Companies are categorized based on their primary source of revenue. Comprised of 114 subsectors, 41 sectors, 19 supersectors, and 10 industries.

Description of Representative Sectors

• Basic materials and processing: building materials, chemicals, paper, and forest products, containers and packaging, and metal, mineral, and mining companies
• Consumer discretionary: cyclical consumer-related products or services
• Consumer staples: non-cyclical consumer-related products or services
• Energy: the exploration, production, or refining of natural resources
• Financial services: banking, finance, insurance, real estate, asset management, and/or brokerage services
• Healthcare: medical products or supplies
• Industrial/producer durables: capital goods manufacturers and providers of commercial services
• Technology: manufacturers or retailers of computers, software, semiconductors, and communications equipment
• Telecommunications: communication services, sometimes grouped in with utilities
• Utilities: electric, gas, water

Governmental Industry Classification Systems

• International Standard Industrial Classification of All Economic Activities (ISIC): adopted by the United Nations in 1948. Classifications are based on the principal type of economic activity the entity performs. Comprised of more than 400 classes, 233 groups, 88 divisions, 21 sections, 11 categories.
• Statistical Classification of Economic Activities in the European Community: the classification of economic activities corresponding to ISIC at the European level. Classified based on the principal type of economic activity.
• Australian and New Zealand Standard Industrial Classification (ANZSIC): jointly developed by the Australian Bureau of Statistics and Statistics New Zealand.
• North American Industry Classification System (NAICS): jointly developed by the United States, Canada, and Mexico. NAICS distinguishes between an establishment (a single physical location where business is conducted) and an enterprise (more than a location performing economic activities).

Question

Drof, a fictional company that manufactures and sells cars, and Snov, a fictional company that owns grocery stores across the United States, are grouped together using one classification approach. Drof’s earnings are closely tied to the strength of the economy, while Snov’s earnings are much less dependent on the business cycle. Despite the differences, the daily stock price movements of Drof and Snov over the last ten years have been strongly correlated. What classification approach is the most likely to group these two companies together?

1. Statistical similarities.
2. Business-cycle sensitivities.
3. Products and/or services supplied.

Solution

The correct answer is A.

The companies have few similarities in terms of products supplied or business-cycle sensitivities, but their statistical similarities would be likely to include them in the same group.