B. Compare and contrast the methods by which companies can be grouped, current industry classification systems, and classify a company, given a description of its activities and the classification system

Question 1

the methods by which companies can
be grouped

Answer 1

Firms can be grouped into industries according to their products and services or business cycle sensitivity, or through statistical methods that group firms with high historical correlation in returns.

Question 2

current industry classification systems

Answer 2

Industry classification systems from commercial providers include the Global Industry Classification Standard (Standard & Poor’s and MSCI Barra), Russell Global Sectors, and the Industry Classification Benchmark (Dow Jones and FTSE).

Industry classification systems developed by government agencies include the International Standard Industrial Classification (ISIC), the North American Industry Classification System (NAICS), and systems designed for the European Union and Australia/New Zealand.

Question 3

3.1 Approaches to Identifying Similar Companies

Answer 3

A peer group is a group of companies engage in similar business
activities whose economics and valuation are influenced by
closely related factors. Comparisons of a company in relation
to a well defined peer group can provide valuable insights into
the company’s performance an its relative valuation.

Industry classification attempts to place companies into groups on the basis of
commonalities. In this section of the review three approaches to Industry
Classification are discussed
1. products and services offered
2. Sensitivity to business cycles
3. Statistical methods – groups with correlated returns.

Question 4

Industry Classification Systems

Answer 4

4. Industry Classification Systems
   4.1 Classification Systems : ‐ commercial industry, sector level, and
   governmental and sub‐industry.
5. Commercial industry classifications include
   – Global Industry Classification Standard
   – Russell Global Sectors: Uses a three tier classification system.
   – Industry Classification Benchmark
   – Commercial classification systems are generally updated more
   frequently than governmental classification systems

• 4.14 Sectors (see text for firm compositions)
– Basic materials and processing
– Consumer discretionary
– Consumer staples including personal care products
– Energy firms
– Financial services
– Healthcare
– Industrial and producer durables
– Technology
– Telecommunications
– Utilities
• (See page 198‐ 199 for useful practice on industry groupings.)

4.2 Government bodies also provide industry classifications
– International Standard Industrial Classification of All Economic Activities
(“ISIC”)
– Statistical Classification of Economic Activities in the European Community
– North American Industry Classification System (“NAICS”)
– Australian and New Zealand Standard Industrial Classification
– Commercial classification systems are generally updated more frequently
than governmental classification systems
– Government systems generally do not distinguish between small and large
businesses, between for profit and not for profit organization or between
public and private companies.

Question 5

Commercial index providers typically classify companies by:

Answer 5

commercial providers such as Standard and Poor’s and MSCI Barra classify companies according to their principal business activity and the products and services they provide.
Commercial providers of industry classification systems such as the GICS classify firms according to principal business activity, such as Consumer Staples, Financial Services, or Health Care.

Question 6

Cyclicals

Answer 6

Auto manufacturing and home building are both cyclical industries. An industry classification system based on business cycle sensitivity would be the most likely to group firms from these industries together.