The stock market classifies stocks in several ways, but one of the most useful methods is by business type. Companies can be grouped into similar industries for the purpose of making similar comparisons (apples to apples). These groupings are called “sectors” and you will read or hear about them many times in relation to the performance of certain sectors of stocks during the past quarter or how they will perform in the near future.
Main Sectors
Almost every company whose shares are traded in the market falls into one of the 11 sectors defined by the Global Industry Classification Standard (GICS). In order from largest to smallest, they are:
- Information Technology
- Healthcare
- Financials
- Consumer Discretionary
- Communication Services
- Industrials
- Consumer Staples
- Energy
- Utilities
- Real Estate
- Materials
Each sector contains many types of businesses and therefore, most sectors can be subdivided into sub-sectors. For example, the Consumer Discretionary sector includes all types of businesses that produce non-essential retail and luxury goods for daily life, such as luxury clothing and fine dining, among others. The Healthcare sector can also be divided into many sub-sectors, such as standard healthcare services, pharmaceuticals manufacturing, medical devices, health data software, and more. Many of these industries do not have much similarity in how they operate; however, their stock prices may reflect the market condition in similar ways.
Defensive Sectors
Defensive sectors include the Utilities and Consumer Staples sectors. Both are generally stable in the market, meaning they are not affected as much as other sectors might be in a market downturn. The reason is simple: even in tough times, people do not completely stop using heat or lighting, nor do they stop eating. These types of stocks can provide balance to portfolios and a means of protection against a market decline.
On the other hand, despite their claim of safety, defensive stocks usually fail to rise as the market rises, due to reasons opposite to their protective measures during a market downturn: in good times, people do not use much excess energy or consume much food.
Defensive stocks do what their name suggests as long as they belong to strong companies. These stocks can provide a cushion for a soft landing in the event of a market decline.
Cyclical Sectors
Cyclical stocks cover every other sector apart from the two mentioned above and react to a wide range of market conditions that can send them up or down. These sectors respond to specific trends or influences and can move independently of each other; when one sector rises, another sector may be in decline. What links them is the way their stock prices can rise or fall with market patterns. This applies to all nine sectors and their sub-sectors as well.
When you dig into the details of how companies actually operate, it makes sense to find that stocks in cyclical sectors move up and down in sync with business cycles and other influences. For example, the Materials sector includes those elements used in making other goods, such as lumber. When the housing market is active, lumber companies’ stock prices rise. In a market dealing with high-interest rates, home sales may be low. This situation will consequently put pressure on home building, reducing the demand for lumber. Soon, the prices of the industry stocks will decrease.
Although it may vary from year to year, the Energy sector is often among the most volatile because it relies on oil, coal, gas, and renewable energies, which are constantly changing. Prices can be subject to change due to factors like oil spills, international conflicts, politics, natural disasters, and other similar uncontrollable forces.
How to
Using This Knowledge
Stock sectors can be considered useful tools for sorting and comparing stocks. There are many summaries and companies that publish statistics by sector, so you should not have trouble finding the data. However, try not to get attached to just one set of sectors. For example, Morningstar uses a slightly different set of sectors than those named by GISC; most of the time, they tell the same story, but each may have something unique to offer. The most important advice is to compare stocks within the sector.
Sector funds, as the name implies, are types of funds that contain stocks from a group of companies within one sector. They come in various forms, such as mutual funds or exchange-traded funds. Sector funds can be useful for individuals looking to focus their money in a certain industry while maintaining diversification in their investments.
Analyzing stocks by sector has become a common practice, as sector information makes it easy to compare how the stocks you currently own, or those you might want to buy, are performing compared to other companies in the same sector. Sector analysis can highlight the fact that while all other stocks are up by 9%, your stock is down by 5%, and you want to know what’s affecting the difference. Similarly, if the numbers are reversed, you’ll want to find out why your stock is performing much better than others in the same sector. Perhaps the company changed its business model, hired a new CEO, acquired a key client, or made another change that led to its success. You’ll want to determine whether the rise is short-term or could be the new normal.
In conclusion, when comparing stocks within a sector, you can reach a deeper level of understanding about your stock’s performance or potential to perform.
Source: https://www.thebalancemoney.com/stock-sectors-how-to-classify-stocks-3141375
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