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yuvaltaylor
beyond sectors: ways to classify industries

The conventional way to classify industries is by grouping them into sectors, as the GICS standard does. I'm interested in alternative approaches. One can be found in Portfolio123's "themes": macro, population growth, special, financial, and innovative. You can read more about that here:

https://www.portfolio123.com/doc/side_help_item.jsp?id=37

I really like this approach. But I was also wondering about alternatives. There's a very short article on the Harvard Business Review - https://hbr.org/2016/08/why-are-we-still-classifying-companies-by-industry - that suggests we classify industries as follows:

Asset Builders make and sell physical things
Service Providers use people to offer services
Technology Creators generate and deliver intellectual property (software and data)
Network Orchestrators facilitate transactions and interactions within a network

This seems like a promising idea, but I think it might be hard to assign certain industries to one of these categories, and I don't know how useful the classification might be. I'm also not aware of anyone who has gone to step two and actually tried to assign industries, subindustries, or individual companies to one of these four categories. I myself wouldn't know where to begin. What category would banks be in? How about insurance companies? How about Netflix?

What I'm looking for is a way to group stocks that exhibit similar behavior based on what business they're in that are somewhat larger than GICS sectors. Does anyone have any ideas about this? P123's "theme" approach is great, and maybe that's the best one available. But if anyone knows of alternatives, I'd love to hear about them.

Yuval Taylor
Product Manager, Portfolio123
invest(igations)

Jan 4, 2019 11:54:12 AM       
jmh
Re: beyond sectors: ways to classify industries

Yuval,

I thought about this type of approach as well.

I have on my to-do list a project which would use the IBD / Marketsmith 197 industry groups.
These groups seem more homogeneous than the GICS codes

First challenge is that they do not reveal how they allocate stocks into each of the 197 groups. One way to do that is to buy the cheapest Marketsmith subscription and to manually export every so often the list of stocks... 197 times! (I did it once)

Second challenge is to find the historical composition of these 197 groups to be able to backtest whatever strategy (using the InList function) ... at least over a few years!

If anyone has any insight / way as for how to proxy the 197 groups, I am interested.
I am also interested in the historical composition of these groups if anyone has it (feel free to email me)

Jerome

Jan 4, 2019 12:09:53 PM       
SpacemanJones
Re: beyond sectors: ways to classify industries

Not sure if any of these qualify, but:

Peter Lynch had some interesting categories in one of his books. One model I remember he mentioned was a consolidator in a shrinking industry. A shrinking industry tends to not attract competition, and the consolidator is gaining market share/pricing power as time passes. I think I've also seen research that returns in more consolidated industries tend to be higher (no surprise I guess). May be a way to "metricize" that.

Lynch also mentioned that coming out of recessions it might be better to invest in the lower quality, more indebted company - as they've often been beaten down most due to bankruptcy risk. It's been so long since I've read his books, but I think he gave examples of industrials like auto manufacturers in those cases. Maybe that's something like a "leader"/"also ran" type categorization?

Lynch was also big on the cookie-cutter expansion type stories. Something that works and can just be rolled out to green pastures. Autozone or Taco Bell is the model. Tends to be retail - not sure if applies in other settings.

Jan 4, 2019 2:06:58 PM       
Edit 1 times, last edit by SpacemanJones at Jan 4, 2019 2:25:24 PM
Tomyani
Re: beyond sectors: ways to classify industries

Yeah. Can also look at basics like:
a) Gross margins of the industry (high, medium, low or deciles)
b) Price to book of the industry (asset intensive or not)
c) Overall growth rates of the industry revenue per employee of the industry (so productivity)
d) Can look at total number of companies and growth in employment of industries
e) Can look at 'public / regulatory barriers' around industries... so, things like utilities...
f) Can look at nature of 'disruption' in the industries (i.e. industries with lower turnover of top 5 players over 10 year period likely have things about them that make disruption harder - legal barriers, capital barriers, talent barriers, etc)
g) WACC of the industry over time
h) Number of ipo's by industry over time
i) Amount of M&A in industry over time

Can likely create 'factor analysis' to break industries / markets into 4 quadrants or multiple deciles (high potential growth&profits vs. low growth & profits) and (likely to see high disruption rates vs. unlikely to be disrupted)... and then group companies into these based on their overall profiles.

Can make a bunch of '2 by 2' 4-quadrant analysis charts like this and use them to order companies various ways.

This could be done in a purely 'math-based' way

"Everyone has a plan until they get punched in the face." Mike Tyson
"It's not supposed to be easy. Anyone who finds it (investing) easy, is stupid." Charlie Munger

Jan 4, 2019 2:38:55 PM       
Edit 2 times, last edit by Tomyani at Jan 4, 2019 2:52:15 PM
yuvaltaylor
Re: beyond sectors: ways to classify industries

This is a really neat idea. If one mapped out all industries along these lines one could easily calculate the correlations between these factors and order the industries accordingly. One could then classify them into groups.

Yuval Taylor
Product Manager, Portfolio123
invest(igations)

Jan 4, 2019 4:02:24 PM       
davidbv
Re: beyond sectors: ways to classify industries

how about this.
Companies in the same industry might have similar NetInc margin+turnover+leverage, ie, the three components for their Dupont analysis would all be in the same range.
Semiconductor manufacturers have similar margins, turnover and leverage. Ditto retailers. Ditto oil refiners.
At least that is my hypothesis. I think the data and tools exist in P123 to collect and bucketize the companies, to see if it works.

David

Jan 4, 2019 4:30:56 PM       
InspectorSector
Re: beyond sectors: ways to classify industries

I have had similar thoughts.

Asset Builders make and sell physical things Service Providers use people to offer service


The problem is that manufacturing and services are blurred with no clear separation. Generally, companies provide both.

My early thoughts on classification:

(1) Input Resources
- energy
- basic materials
- human resources??

(2) Business-to-Business
- advertising
- office products
- outsourcing

(3) Business-to-Consumer
- consumer staples
- consumer discretionary
- social

(4) infrastructure and government
- transportation
- aerospace & defense
- utilities
- internet

(2) Facilitators
- banks
- insurance

Jan 4, 2019 4:56:05 PM       
yuvaltaylor
Re: beyond sectors: ways to classify industries

I really like your idea, Inspector. It's a great start.

Yuval Taylor
Product Manager, Portfolio123
invest(igations)

Jan 5, 2019 12:26:30 PM       
InmanRoshi
Re: beyond sectors: ways to classify industries

Good topic. I've been thinking about this a lot recently, specifically how a "technology" sector is basically meaningless as technology is ubiquitous across all sectors. If Disney is streaming video into your home for a subscription and Netflix is streaming video into your home for a subscription, why does Netflix get put in the technology sector worthy of a 105 PE while Disney has the 13 PE.

Jan 5, 2019 6:23:53 PM       
InspectorSector
Re: beyond sectors: ways to classify industries

I believe that the GICS is obsolete, but there is a huge business feeding off of it. Technology is a good example. Some hedge funds are starting to base their classification systems on A.I. The results may not be any better, but a lot less expensive.

Jan 5, 2019 7:23:12 PM       
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