Chapter 14: Industry classification

Question 1

Features used to categorise an ordinary share

Answer 1

• Industry
• Marketability
• Market capitalisation
• Price earnings ratio or dividend yield
• Level of gearing
• Exposure to overseas earnings
• Cyclical vs. defensive shares (exposure to the economic cycle)

Question 2

Reasons for categorisation by industry

Answer 2

• Practical for analysists to specialise in one area
• Correlation of investment performance

Question 3

Why is it practical for analysists to specialise in one industry?

Answer 3

• Factors affecting one company are likely to be relevant to others in the same industry
• Assists in portfolio classification and management
• No one can expect to be an expert in all areas
• Info will come from common source and presented in a similar way
• Grouping of equities gives structure to the decision-making process

Question 4

Why are share prices of companies in same industry correlated?

Answer 4

• Similar financial structures and so are similarly affected by changes in interest rates
• Supply to the same markets so are similarly affected by changes in demand
• Same resources so have similar input costs

Question 5

Difficulties of categorisation by industry

Answer 5

• Conglomerate companies (several sectors)
• Multinationals (several marketplaces)
• Differences between companies within the same sector - e.g. due to size or operate within niches of the market

Question 6

FTSE industry classification system

Answer 6

• Financial companies
• Telecommunications
• Utilities
• Industrials
• Healthcare
• Technology
• Energy
• Basic materials
• Consumer goods
• Consumer services

Question 7

Energy

Answer 7

Involved in extraction and supply of oil and gas products as well as the production of renewable energy
They are usually:

• large companies
• commodity price dependent
• higher risk (especially smaller exploration companies)
• global

Question 8

Basic materials

Answer 8

Includes the chemical and the mining industry, companies producing steel and other metals and those engaged in forestry and paper.
Mainly produce ‘intermediate’ goods.

Question 9

Industrials

Answer 9

Involved in various stages in the supply and production of goods. Goods tend to be capital items. Includes companies in building material, construction industries, industrial transportation and industry support services.
Distinctive features:

• dependency on level of government spending
• cyclical in nature
• company profits tend to move ahead of the trade cycle
• volatility of profits
• high profit margins when conditions are good
• low gearing because of volatile profits
• possibility of exposure to overseas markets and competition

Question 10

Consumer goods

Answer 10

Manufacture consumer durables and non-durables
Non-durable consumer goods are less cyclical (esp. basic necessities)
Other key features:

• increasingly capital intensive
• moderate to high gearing
• low profit margins

Question 11

Healthcare

Answer 11

Covers healthcare providers, medical equipment and supplies as well as pharmaceuticals

Question 12

Consumer services

Answer 12

Food and drug retailers, general retailers, media and travel & leisure companies

• Impact of economic cycle will be greater on the cyclical companies
• Labour-intensive
• More defensive companies in the group may have high gearing
• Domestic market is the most important

Question 13

Telecommunications

Answer 13

Providers of fixed line and mobile telephone services
Type of utility - But less regulated and hence more volatile

Question 14

Utilities

Answer 14

Involved in supply of continuously demanded services to households and business premises (electricity, water and gas)
Key features:

• demand is stable because market share stable (natural monopolies) – less affected by economic cycles.
• extensive physical infrastructure = capital intensive.
• subject to tight government regulation of prices and vulnerable to other forms of political risk
• low growth prospects = high gross dividend yield.
• despite stable demand & large capital requirements = low gearing (operational gearing may be high)
• largely dependent on domestic market – some diversifying internationally.

Question 15

Financials

Answer 15

Banks, general insurance companies, life assurance companies, investment trusts and real estate companies
Key features:

• Tend to be capital intensive
• banks are 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 are important for many companies in the group
• domestic market is most important but there’s increasing internationalisation

Question 16

Technology

Answer 16

Companies involved in software & computer services, and technology hardware & equipment

• Dividend yields are low - Few are yet to make profits while demand from investors has been high (therefore high price)
• Assets can be largely intangible