13 - Industry Classification

Question 1

Give features of ordinary shares that can be used to categorise them.

Answer 1

1. Industry
2. Marketability - size of the company
3. Market capitalisation
4. Price earnings ratio or dividend yield
5. Gearing
6. Exposure to overseas earnings - national or multinational
7. Cyclical or defensive shares

Question 2

Define cyclical and defensive shares.

Answer 2

Cyclical - shares where the earnings of the company that are sensitive to the economic cycle that the business is exposed to

Defensive - shares where the earnings of the company are not very affected by economic cycles

Question 3

Give the reasons for using industry categorisation for companies and shares

Answer 3

1. Practicality

2. Correlation with investment performance

Question 4

Give the reasons why industry categorisation is practical.

Answer 4

1. The factors affecting one company within an industry are likely to be relevant to other companies in the same industry
2. Much of the information for companies in the same industry will come from a common source and will be presented in a similar way
3. No single analyst can be expected to be an expert in all area, so specialisation is appropriate

Question 5

Give the factors that influence a company in a certain sector that affects other companies in the same sector

Answer 5

1. Resources: input costs
2. Structure: gearing and changes in interest rates
3. Markets: target markets

Question 6

Give some practical difficulties with industry classifications

Answer 6

1. Conglomerates: mergers and acquisitions
   - similarly for multinationals
2. Heterogeneity within sectors due to size or niche markets

Question 7

What is the aim of the FTSE?

Answer 7

To group companies into subsectors that contain companies with the similar sources of revenue or where it constitutes the majority of revenue