Industry Groupings - Tracking the different sectors of the economy
By Patrick van Beek, managing Proprietor of Caribbean Actuarial & Financial Services The Finance and Investment Column This column provides informative commentary on financial matters.
Business December 24, 2004
Stabroek News
December 24, 2004
If you examine the pages of the Financial Times or Wall Street Journal you will probably notice that information relating to shares is grouped by industry categories. If you have ever wondered why read on! Industry groupings are useful to analysts for a number of reasons. In larger economies it is unlikely that a single analyst will be able to cover all companies which are listed. In Guyana there are thirteen companies whose shares are eligible for trading in the secondary market, only five of which see regular activity. Four companies on the board have yet to see a trade, of which two have not even seen a single bid or offer. Compare this with a market like the London Stock Exchange where there are around two thousand companies listed and still further companies whose shares trade on the secondary market (called the alternative investment market or AIM for short). While it does not take too much of a stretch to imagine a single analyst coping with all companies trading here, imagine trying to do an in-depth analysis of all companies traded in London. Even at one a day (including weekends) it would be five and half years before you made it through them all.
Concentrating on a group of companies provides a natural structure to analysis. Suppose you want to asses the prospects of one of the commercial banks here in Guyana. You would start by collecting as much information about the factors that might impact on its profitability, which broadly depend on interest income, interest expense and administration expenses. You might look at trends in lending and deposits; interest rates on loans, investments and deposits; the extent and incidence of non-performing loans; the money supply and perhaps even population projections along with the extent of competition in the banking sector. Given that nearly all of the factors above are relevant to almost every bank in the sector, it is natural to extend the analysis to another commercial bank after completing the analysis of the first one. If not for this reason alone it makes sense for analysts to specialise within a particular sector. When you consider that much of the information for companies in the same industry will be from a common source and will be presented in a similar way, and in a large market no one analyst can expect to be an expert in all areas, grouping by sector seems a very practical idea.
From the above you might think the groupings are all for the analyst's benefit! There is another compelling reason to group companies together - the correlation of investment performance. After overall market movements have been taken into consideration, the share price movements of companies in similar industries tend to be more closely correlated with each other than with companies in other industries. Changes in the operating environment of one company are likely to affect its peers in similar ways. Consider two companies making competing products. They will use similar resources, such as labour, land and resources so will face similar input costs. They will share a common market and will both be affected by changes in demand for the product. Finally, the companies may have similar financial structures so may be similarly affected by changes in interest rates.
One potential grouping which could be used is Mineral Extraction, General Industrials, Consumer Goods, Services, Utilities and Financials. In fact these were the groupings used by the London Stock Exchange until 1998 when they were updated to facilitate cross-national (in particular, pan-European) industrial analyses, including the UK, with a single classification system. These broad economic groupings were subdivided into industrial sector, eg Financials was subdivided by Retail Banks, Merchant Banks, Life Insurance, Other Financial and Property.
The trouble with applying the industrial sectors groups to Guyana is that many of them would only have one traded company (if at all) in them. I think a better place to start would be the economic groups. As and when there are enough companies traded to warrant industrial sectors they can be added. I have suggested the following groupings for each of the stocks which trade on the exchange, together with the industrial sector I would put them in.
stocks have not traded, will be included upon first trade
Putting these groupings together, one of the difficulties in practice became apparent: several of the above companies operate in more than one economic grouping and/or industrial sector. Examples include: DIH having a food retailing division and a commercial bank as a subsidiary, JPS also acting as retailers, DDL having numerous subsidiaries and with the completion of the parboiled rice mill GSI will move into food production. However, I have tried to place the above companies by their primary source of business.
I would be interested if anyone has any feedback on these groupings. They are not set in stone: so if you have any comments or disagree with my groupings, I would welcome any comments and I can be contacted by email at patvanbeek@yahoo.co.uk.
Another benefit of industry groupings is relative strength analysis. For those that subscribe to technical strength analysis comparison of stock with sector or sector with market, reveals which stocks and sectors have been under and over performing. Spotting these trends and reversals in them will identify which stocks and sectors to invest in.
There will be no column next week as Stabroek Business breaks for Christmas, the following week, see how the economic groups compare with the market as a whole, the individual stocks, inflation and cash as we take a look at the winners and losers of 2004.