Industry classification: GICS, ICB, TRBC and other groupings

What are industry classification schemes?

An industry is a group of firms that offer comparable products or services from the customer’s point of view. Such firms tend to face similar competitive forces and value drivers, which is why the industry matters for every valuation approach, not only for choosing peers for a multiple.

Deciding where a firm belongs is the first step, and analysts usually start from a commercial scheme:

• The Global Industry Classification Standard (GICS) , from MSCI and S&P Dow Jones Indices (S&P stands for Standard & Poor’s).
• The Industry Classification Benchmark (ICB) , from FTSE Russell.
• The Refinitiv Business Classification (TRBC) , from Refinitiv.

All three are global, group companies by the similarity of the products and services they offer, and are reviewed and updated at least once a year, with new companies added more often. GICS and ICB cover public companies; TRBC also covers private companies, non-profits and government bodies. Data services and exchanges use these schemes or close copies of them.

Some schemes are regional: the North American Industry Classification System (NAICS) and the European Nomenclature of Economic Activities (NACE) are used within those regions.

Classification schemesa starting point for defining an industry

• Global commercial schemes Memorize one group per company, reviewed at least annually
  • GICS MSCI and S&P Dow Jones Indices; public companies
  • ICB FTSE Russell; public companies
  • TRBC Refinitiv; also private, non-profit, government
• Regional schemes Know the idea used within a region
  • NAICS North America
  • NACE Europe
• Segment tools Know the idea for companies with several businesses
  • BICS splits a company's segments across groups

How are companies placed in the hierarchy?

The three schemes are each a hierarchical taxonomy , like the species, genus and family ranking in biology. A company is placed in one group at the lowest tier, and that placement fixes its groups at every higher tier. GICS runs sector, industry group, industry, sub-industry. ICB runs industry, supersector, sector, subsector. TRBC runs economic sector, business sector, industry group, industry, activity.

A company with one line of business is placed by that business. A company that operates in several industries still gets one place: the group of its largest product or service by revenue.

To see a company’s other businesses, some data services break its segments across several groups. The Bloomberg Industry Classification Standard (BICS) does this, so an analyst can find the competitors of each segment.

Where do the standard schemes fall short?

Memorize

A scheme is a starting point. Four limitations matter, and each one has a typical exam clue.

Limitations of GICS, ICB and TRBCcheck that classified companies really compete

• Business model variations and substitutes Memorize groups too broad or too narrow
• Companies in multiple industries Memorize one group, by largest revenue line
• Geography Memorize global groups fit global industries, not local services
• Changes over time Memorize reclassifications, listings and delistings break comparability

1. Business model variations and substitutes. Two companies filed under “specialty chemicals”, one making paint additives and one making battery electrolytes, sell to different customers and never compete. Conversely, a neighborhood café and a supermarket with a ready-meals aisle may fight for the same customer’s lunch while sitting in different groups. Substitutes cross group lines.
2. Companies operating in multiple industries. With one group per company, chosen by its largest product or service by revenue, a division can compete with firms in a different sector from its parent. Picture a consumer electronics maker whose payments division earns most of its profit: the label says electronics, but that division’s rivals are banks and card networks filed under financials.
3. Geography. Global groupings suit global industries, such as manufactured goods and digital products. They suit local services poorly. Dental clinics, driving schools and home-care agencies compete town by town, because customers will not travel far and licensing is often national, so a chain in one country has little in common with one abroad. Industries can also change: private tutoring was once local, and online lessons have made much of it a global market.
4. Changes in groupings over time. Providers create, rename and move groups, and companies enter and leave through listings, acquisitions and bankruptcies. Long histories of an industry then mix different companies, which can distort historical return statistics. Use history restated to the latest groupings. Suppose a provider moves satellite operators out of telecommunications into a new space-services industry: ten years of telecom statistics now describe a different set of firms.

The groups can be too narrow or too broad. The fix is to move up or down a tier, or to modify the group: add the rivals the scheme files elsewhere and remove companies that do not really compete.

What other ways are there to group companies?

Two alternatives: by geography and by sensitivity to the business cycle. They can be combined, which helps when countries are at different points in the cycle.

Grouping methods besides industrycan be combined, as countries sit at different points in the cycle

• Geography Use it by country, then developed, emerging or frontier
  • Country set by incorporation, primary listing or headquarters
  • Not set by where revenue is earned or assets sit
  • Then grouped as developed, emerging, frontier
• Business cycle sensitivity Memorize cyclical, defensive or growth
  • Cyclical discretionary, durables, commodity inputs
  • Defensive essentials, inelastic demand
  • Growth above-trend growth whatever the cycle

Geography. Companies are assigned a country, then countries are collected into developed, emerging and frontier markets . The country is set by where the issuer is incorporated, where it has its primary listing, or where its headquarters is. The mix of revenue by region is generally not used, even though it may matter most to the analyst. A company incorporated, listed and headquartered in Korea that earns most of its sales in Europe is still a Korean company. Why group by country at all? Companies in one country share its economic conditions and its political, economic and social policies, so they can have more value drivers in common than companies in the same industry spread across many countries.

Business cycle sensitivity. Cyclical companies see bigger swings in revenue and profitability over the business cycle. Typical sources: discretionary goods and services; durable goods such as housing, cars, appliances and capital equipment; commodity inputs such as lumber, steel and copper; and some business services, such as renting out heavy equipment. High fixed costs magnify the swings in operating profit. Defensive companies see their sales growth, profitability and valuations change much less with the economy, because they sell essentials with inelastic demand. By sector: consumer staples, health care and utilities are usually defensive; financials, basic materials, consumer discretionary and industrials are usually cyclical.

A third group, growth companies , is relatively insensitive to the cycle: revenue grows quickly, well above the economy, in good years and bad, often from a new technology or treatment. They may or may not be profitable yet. The questions are how long the above-trend growth lasts and how profitable the company will be once it matures.

Go deeper Why defensive does not mean immune

A severe downturn hurts almost every company, so the difference between cyclical and defensive is a matter of degree. Companies at different stages inside one industry can also differ: a young firm with a new technology may keep growing in a cyclical industry that is shrinking overall. Treat the label as a good first guess about sensitivity, and check how the business model works: whether purchases can be postponed and how much debt the customers carry.

Go deeper Why classification matters beyond research

Index providers use the same schemes to build sector indexes, and funds and benchmarks follow those indexes, so a company’s classification affects which sector funds hold it and what weight it carries. Performance attribution also reports results by sector using these groups. Peer groups for multiples in Learning Module 7 start from the same tiers.