Lesson 7: Sectors & Industries: How Stocks Are Grouped by Business Type

Sector and industry are ways of grouping companies based on what type of business they operate.

For example, Amazon (AMZN) is grouped into the Consumer Discretionary sector. And within that sector, it’s considered to be in the Internet & Direct Marketing Retail industry.

Other well-known Consumer Discretionary sector stocks include Home Depot (HD), Toyota (TM), McDonald’s (MCD), Nike (NKE), Target (TGT), and eBay (EBAY).

There’s a Global Industry Classification Standard (GICS) that organizes all public companies into 11 major sectors. Within those sectors, companies are broken down into industry groups, industries, and sub-industries.

You can see detailed groupings on the GICS website and below:

Here are the 11 major sectors that make up the stock market and a few example industries for each:

  1. Financials: Banks, investment funds, insurance, loans, asset management
  2. Utilities: Electric, gas, water
  3. Consumer Discretionary: Retailers, media, consumer services, auto, restaurants, lodging, entertainment
  4. Consumer Staples: Food and beverage manufacturing, household goods, personal products, household products, tobacco
  5. Energy: Oil, gas, power, refineries, pipeline operators
  6. Healthcare: Biotech, hospitals, medical devices, pharmaceuticals
  7. Industrials: Construction, defense, aerospace, machinery, hand-held tools, transportation
  8. Information Technology: Electronics, software, semiconductors, computer equipment, data storage
  9. Communications: Wireless, cable, internet providers
  10. Materials: Mining, chemicals, raw materials, building materials, paper products
  11. Real Estate: Residential, commercial, industrial real estate

You can explore all sectors and industries here with Fidelity.

What Drives Stock Returns in Each Sector?

The stocks in each sector and industry tend to look and behave similarly because they operate the same types of businesses, products, and services.

For example, tech stocks often grow their sales at a similar rate, which is very different than how fast real estate stocks grow their sales.

The same concept applies to how stocks in different sectors create profits for their shareholders. 

This chart from J.P. Morgan shows how much each sector has relied on price gains vs. dividends to deliver its profits over the last 25 years.

We can see that slow-growth sectors such as Real Estate and Communications have relied heavily on dividends to drive their returns. Contrast that against fast-growth sectors like Technology and Health Care which have relied mostly on price gains to drive their returns.

Stocks in Cyclical vs. Defensive Sectors

Sectors are often divided into three categories: Cyclical, Defensive, or Sensitive.

Cyclical sectors are closely tied to the strength or weakness of the broader economic backdrop. If the economy is thriving, companies in cyclical sectors tend to thrive as well. And if the economy is struggling, cyclical sectors and companies also tend to struggle.

For example, car manufacturers, which are found in the Consumer Discretionary sector, are cyclical in nature. When the economy is thriving, unemployment is low, and wages are rising, you might feel enough financial confidence to go buy a brand new car.

But, when people are losing their jobs and the economy has dark clouds on the horizon, you might hold off on buying that new car, instead trying to stretch your existing clunker as far as you can.

These sectors are usually considered cyclical:

  • Materials
  • Consumer Discretionary
  • Financials
  • Real Estate

Opposite to cyclical sectors are defensive sectors.

Defensive sectors are not as closely tied to what’s happening in the broader economy. Companies within these sectors tend to perform pretty steadily, regardless of what’s happening in the economy.

For example, the Healthcare sector is consider defensive because people tend to use health services regardless of how the economy is doing. If you break your leg skiing, you’re headed to the hospital regardless of the current unemployment rate.

These sectors are usually considered defensive:

  • Consumer Staples
  • Healthcare
  • Utilities

In between cyclical and defensive are sectors considered “sensitive.” 

Sensitive sectors move with the overall economy but not excessively so. 

Sensitive sectors include:

  • Communication Services
  • Energy
  • Industrials
  • Technology

Research suggests that some sectors can perform better or worse during different parts of the business cycle.

The business cycle is the repeated rise and fall of economic activity over time. Historically, this cycle has gone through four major stages:

  • Expansion: Economic growth is strong, unemployment is low, stocks are going up.
  • Peak: The point when the expansion has reached its end and the economy is tipping towards contraction.
  • Contraction: Economic growth is weak, unemployment is rising, stocks are going down.
  • Trough: The point when contraction has reached its end and the economy is moving towards expansion.

This chart from Fidelity shows how different sectors are expected to perform at different points in the business cycle:

Sector Scoreboard

J.P. Morgan provides a giant scoreboard of each sector as of September 30, 2018.

Here are some interesting things to note:

  • The Consumer Discretionary and Technology sectors have performed the best since the stock market’s low in 2009 – up 765% and 656%, respectively.
  • The Energy and Communication Services sectors have performed the worst since the stock market’s low in 2009 – up 129% and 197% respectively.
  • Utilities and Real Estate currently offer the highest dividend yield – both at 3.6%
  • The Energy, Technology, and Materials sectors all earn more than half their sales from overseas.
  • Based on P/E ratio (price to earnings ratio), Financials and Materials currently appear the most undervalued.

Sectors & Industries: Lesson Summary

Despite the fact certain sectors as a whole have performed well over the last 25 years, we wouldn’t focus on buying stocks in just those sectors.

Our research has shown you can find high-performing stocks across many sectors using proven investment strategies and styles. Let’s look at the most common ones now: Lesson 8: Investing Styles & Strategies: 17 Ways Investors Make Money in Stocks

Also, this marks an important milestone – you’ve completed Level 1 of this course!

Next up, let’s quickly summarize everything you’ve learned so far in Level 1. Then in Level 2 we’ll walk through how to make (and keep) stock profits.

LEVEL 1 SUMMARY: Stock Market Investing for Beginners

Author

Todd Lincoln

Author

Passionate stock market investor with deep experience trading small cap, dividend, and growth stocks.

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