Grouping stocks by common industries is an important step in analyzing stocks. Investors in the stock market call these groupings sectors.
Stock sectors group like companies so you can follow broad sections of the market without having to follow individual stocks. You can also track the performance of an individual stock against its sector's performance.
This is often a better way to look at market activity than relying on stock indexes that group dissimilar companies by size. When you can compare a stock to its peers, you have a better idea of how it is performing.
One classification breaks the market into 11 different sectors, however you may see other sector lists that have more than 11
Two of the sectors are considered "defensive or noncyclical" and the remaining nine "cyclical." Let's look at these two categories and see what they mean for the individual investor.
Defensive Sectors Defined
Defensive sectors include utilities and consumer staples. These companies provide basic necessities and usually do better in a market downturn because people don't stop using energy or eating. They provide some stability to portfolios.
Defensive stocks usually do not grow in a rising market for the opposite reasons they provide protection in a falling market: people don't use significantly more energy or eat more food.
Defensive stocks offer a relatively stable anchor amid market chaos. Many defensive stocks also pay dividends, which helps offset slow growth.
Cyclical Sectors
Cyclical stocks, on the other hand, tend to react to a variety of market conditions that can send them up or down, however when one sector is going up another may be going down.
Here is a list of the nine sectors considered cyclical:
- Basic Materials - Basic materials include those items used in making other goods - lumber, for instance. When the housing market is active, the stock of lumber companies will tend to rise.
- Capital Goods - Capital goods sector contains manufacturers of industrial equipment, defense (as in military) goods, aerospace, construction and so on. This sector is also very sensitive to the economy.
- Communications - These companies are in the telecommunications business as well as wireless (cell phones, for example) carriers.
- Consumer Cyclical - This sector is very sensitive to the economy. It includes automotive, entertainment, retail and housing. When the economy is good these sectors flourish. Not so much is a slow economy.
- Energy - This sector includes those companies involved in the exploration for and distribution of natural resources such as coal, oil, gas and so on, but not utilities.
- Financial - The companies in this sector include banks and other deposit-taking companies, stock market participants, such as brokers, investment banks and so on.
- Health Care - The health care sector includes hospitals, clinics, health care management companies and medical products. Some put this sector in the defensive category because people still need care, however in tough economic times, people will put off preventive care, for example.
- Technology - This sector contains companies that make their money on their technology or supplying technology companies. Computer manufacturers, software, hardware and so on are some of the products they produce. New or significant advances in technology can cause a stir and push this sector up.
- Transportation - Airlines, trucking companies, railroads and other companies that move goods or people make up this sector.
Companies in the various sectors may or may not react the same as the whole sector, which can indicate good or poor management depending on the way the company moves.
Reporting Sectors
There are a number of ways to report stock sectors, depending on how fine they are sorted. One of the most popular sorts is by Morningstar.com.
Morningstar groups stock into 11 categories.
The sectors are market-cap weighed, which gives more importance to larger companies.
Their chart tracks returns for:
- Five days
- Year-to-date
- One month
- Three month
- One year
- Three year
- Five year
What you see is a very different picture for the various stock sectors. Some are down sharply over the near past, but better when looking back three to five years.
Of course, when you limit all stocks to 11 sectors, you will find some wide variations within each sector.
Other sectors look better in the near past, but show weakness when viewed over longer periods.
The lesson for stock investors is to be thoughtful about what you buy and sell and look at performance as compared to stock sectors as well as total market indexes.
Comparing one stock's performance to its sector is another way to judge how well or poorly it has been performing. Stocks that consistently underperform their sector are suspect, while a stock outperforming its sector may be a buy candidate.
