Navigating Industry Classification and Analysis | CFA Level I

Today, we’re diving into the vital aspects of industry and competitive analysis. Understanding the landscape of the industry in which a company operates is crucial for assessing its performance and forecasting its future prospects. Let’s explore how industries are classified and analyze the key components that drive industry dynamics.

Why Industry Analysis?

Industry analysis is indispensable for gauging a company’s market position and its potential for sustained profitability. It helps to:

• Understand the inherent profitability and risk factors of the industry.
• Assess a company’s competitive strategy and positioning within the industry.
• Identify investment opportunities by evaluating the industry’s overall health and growth prospects.

Steps in Industry Analysis

Conducting a thorough industry analysis involves a structured approach:

1. Define the Industry: Use classification systems to categorize companies based on their primary products or services.
2. Survey the Industry: Examine size, growth, profitability, and market share trends.
3. Analyze Industry Structure: Apply frameworks like Porter’s Five Forces to understand competitive forces at play.
4. Identify External Influences: Consider political, economic, social, technological, legal, and environmental impacts (PESTLE).
5. Analyze Competitive Strategies: Assess how companies differentiate themselves and their competitive advantages.

Industry Classification Systems

Industry classification plays a pivotal role in grouping companies for analysis. Key global classification standards include:

• Global Industry Classification Standard (GICS)
• Industry Classification Benchmark (ICB)
• Refinitiv Business Classification (TRBC)

These systems organize companies into hierarchical categories based on their primary business activities, offering a structured approach to industry analysis.

Challenges in Industry Classification

While classification systems provide a foundation for analysis, analysts should be mindful of their limitations, such as:

• Overly broad or narrow categories that may not accurately reflect competitive dynamics.
• Misclassification of diversified companies, which could skew analysis.
• Periodic changes in classification schemes that affect longitudinal studies.

Alternative Grouping Criteria

Beyond commercial products or services, companies can also be grouped based on:

• Geography: Incorporating where companies are incorporated, listed, or operate.
• Sensitivity to Business Cycle: Differentiating between cyclical and defensive companies.
• Statistical Similarities: Using financial metrics for cluster analysis.
• ESG Characteristics: Evaluating companies based on environmental, social, and governance factors.

Key Takeaways

Understanding industry classification and analysis is crucial for any financial analyst. It not only helps in evaluating a company’s current standing and future potential but also uncovers broader investment opportunities within the industry. By applying both traditional and innovative classification criteria, analysts can gain deeper insights into the competitive landscape and strategic positioning of companies.