Chapter 14: Industry classification

Question 1

m) investment indices constructio & features of major investment indice

Outline the main reasons for categorisation of shares by industry.

Answer 1

1. Practicality
   - Same facttors affect companies in the same sector
   - Information about these companies come from common sources and is presented in similar ways
   - No analyst can be an expert in all areas, specialising appropriate
   - brings strucutre to the decision making process and portfolio classification and management
2. Correlation of investment performance
   - Movements within industry groups are correlated
   - Companies in the same industry use common:
   • Resources - (labour, land and raw materials) and therefore have similar input costs
   • Markets - supply to same markets –> therefore affected similarly by changes in demand
   • Structure - similar financial structures and therefore affected by similarly by changes in interest rates.

Question 2

m) investment indices constructio & features of major investment indice

List features of ordinary shares that might be used to categorise individual shares.

Answer 2

• marketability
• market cap
• PER and dividend yield
• gearing
• exposure to overseas earninigs
• how sensitive the earnings are to the economic cycle

Some of these features are related

Question 3

m) investment indices constructio & features of major investment indice

Outline the problems with industry classification.

Answer 3

1. Heterogeneity of companies within the same industry (e.g., due to size or operating within different niches of the market)
2. Conglomerates
   - becoming more of a problem as companies diversify by means of mergers and takeovers…
   - …leading to the same company operating in different sectors
   - same issue with multinational companies operating in several different market places.

Question 4

m) investment indices constructio & features of major investment indice

What is the main aim of the FTSE industry classification system?

Answer 4

Aim of the system is to group individual companies into subsectors based primarily on the company’s source of revenue or where it constitutes the majority of revenue

Question 5

m) investment indices constructio & features of major investment indice

List the ten industry groups used in the FTSE industry classification system.

Answer 5

1. Financials
2. Technology
3. Basic Materials
4. Utilities
5. basic Materials
6. consumer Goods
7. Industrials
8. consumer Services
9. Healthcare
10. Oil & Gas
11. Telecommunications

FT MUG IS HOT

Question 6

m) investment indices constructio & features of major investment indice

Define Oil and Gas economic group.

List four typical characteristics of such companies.

Answer 6

• Involved in the extraction and suppy of oil and gas products.

With the renaming to ‘Energy’, companies involved in renewable energy will also be included

Key characteristics:
1. large
2. commodity price dependent (US $ denominated)
- closely related to movements in oil prices
- and similar to dollar investments
3. high risk
4. global (multinational)
- state of the world more important than domestic state.

Question 7

m) investment indices constructio & features of major investment indice

State the types of companies in the basic and industrial sectors.

List eight distinctive features of industrial copmanies.

Answer 7

• Basic materials produce mainly intermediate goods, e.g., chemicals, forestry, paper, building material and metals.
• Industrials produce main capital goods, e.g., aircraft, ships, machinery, electronic and electrical equipment.
• Includes building material and construction as well as industrial transportation and industry support services.

Eight distinctive features:
1. dependency of the level of investment spending
2. cyclical in nature
3. company profits tend to move ahead of the trade cycle
- capital expenditure greatest at the start of rapid economic growth
4. dependency on government spending
5. volatility of profits
- volatile demand for capital goods –>winning or losing contracts (large unit production size)
6. high profit margins when conditions are good
7. low gearing because of volatile profits
8. possibility of exposure to overseas markets and competition

Question 8

m) investment indices constructio & features of major investment indice

Describe the types of companies in the consumer goods sector.

List four key features of such companies.

Answer 8

• Manufacture consumer durables (cars, furniture, televisions and “white gooods” and non-durables (food and drink, tobacco, health and household products, beverage and packaging)

Four key features:
1. Cyclical (durables) non-cyclical (non-durable)
2. increasingly capital intensive (increasing mechanisation of production process, decreasing labour intensiveness)
3. moderate to high gearing. (highest when profits are stable). Profits generally more stable due to small unitd of good sold which reduces the dependence on individual customers.
4. low profit margins - due to extreme competition

Question 9

m) investment indices constructio & features of major investment indice

List the types of companies found in the consumer services sector.

State three key features of such companies.

Answer 9

• Consumer service companies include food, drug and general retailers, transport, hotel and media companies, distributors, restaurants and pubs and support services.

Three key features
1. labour intensive (except where property costs are high, e.g., hotels)
2. more defensive companies in this group have high gearing (those with stable demand)
3. domestic market is most important (supply mostly to domestic market)

Question 10

m) investment indices constructio & features of major investment indice

Describe the types of companies in the utilities sector.

List key features of such companies.

Answer 10

Supply continuosly demanded services to households and business premises, e.g., water, electricity and gas distribution.

Six key features:
1. Vulnerable to political risk, price controls and changes in regulations where they operate.
2. Require extensive physical infrastucture; hence capital-intensive
3. Mostly natural monopolies.
4. Generally have low growth prospects; leading to high gross redemption yield.
5. Despite stable demand and large capital requirements, financial gearing is low.
6. Largely dependent on domestic markets, although some companies diversifying internationally.

Question 11

m) investment indices constructio & features of major investment indice

Describe companies found in the financials sector.

Answer 11

• Includes banks, general insurance, life insurance, investment trusts and real estate companies
• Tend to be capital intensive, otherwise:
  
  • Banks highly geared and have volatile profits
  • General insurers have volatile profits and virtually no borrowings
  • Life insurers have stable profits and low gearing
  • Labour costs important for many companies in this group
  • Domestic market most important but increasing globalisation

Question 12

m) investment indices constructio & features of major investment indices

Describe the companies in the technology sector.

Answer 12

• Companies involved in hardware, software and provision of computer services.
• Many companies yet to make profits or pay dividends
  (increased investor demand has caused share price to rise dramatically)
• Dividend yields are therefore low, and assets can be large intangible.

Question 13

m) investment indices construction & features of major investment indice

Describe companies found in the healthcare sector.

Answer 13

• Companies involved in providing healthcare, medial equipement and supplies, as well as pharmaceuticals.
• Tend to be non-cyclical.

Question 14

m) investment indices construction & features of major investment indice

Describe the companies found in the telecommunications sector.

Answer 14

• companies involved in fixed line and mobile telephone services.
• type of utility but less regulated hence more volatile.