1. Money

Understanding Stock Sectors for Evaluating Companies

Use Sector Comparisons for More Complete Picture

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Investors in the stock market need to be able to compare a company with its peers when evaluating a stock for purchase.

This "apples to apples" comparison helps you understand whether the stock is performing as well as, better than or not as good as other companies in the same sector.

You can also use stock sectors to avoid placing too much of your portfolio at risk for the same adverse economic situation since stock sectors may react differently to changes in the economy.

There are several methods for defining stock sectors and you can find two of the most commonly used lists at, Yahoo and MorningStar.com.

You'll quickly notice that each broad sector can be subdivided into many subsectors. When you begin drilling down in the valuation of the stock you will want to use the subsectors to isolate peers for direct comparison.

Here are nine stock sectors and their definitions so you better understand what it is you're looking at. These broad sectors can be further broken down into subsectors as noted above.

Not everyone uses the same nine sectors and there may be some variation in exactly how they define them. But you'll get the general idea by going through these nine sectors.

Basic materials

Companies in the basic materials sector are involved in extracting and processing raw materials for further use in the industrial processing.

Companies in this sector include chemical plants, mining of ores such as iron and other producers or refiners of raw materials.

Companies in this sector react to supply and demand of the basic product and respond to the business cycle, meaning an economic slowdown or recession could negatively impact the company.

Capital goods

This sector, also referred to as the industrial sector, includes companies that are involved in manufacturing goods and machinery.

The capital goods sector can be sensitive to the business cycle and may slow down or suffer adverse conditions in a recession or economic slowdown.

Communications

This sector include includes television stations, radio stations, newspapers digital properties and other companies involved in the communications process.

Many of these companies rely on advertising revenues to some degree or the other and will not usually fare well in a recession or economic slowdown.

Consumer cyclical

Companies in this sector are especially vulnerable to economic slowdowns and other adverse business cycles.

Products and services produced in the sector fall into the discretionary income category as opposed to a necessity. This makes them extremely vulnerable to economic slowdowns and may have an adverse impact on the stock price.

Energy

The energy sector is fairly self-explanatory and involves production and distribution of energy resources including oil and gas. They are sensitive to not only the business cycle but world political events which can drive up or drive down profits.

Financial

Companies in this sector include banks and insurance companies, investment companies, such as mutual funds and stock brokerage along with other diverse financial companies. Since many of these companies rely on interest income from loans such as mortgages they are very sensitive to interest rate changes.

Health Care

The health care sector is fairly self-explanatory. It includes health care institutions such as hospital management companies, but also some biotech firms and medical equipment.

This sector was once considered a defensive stock since people needed to go to the doctor when they were sick. That is still true, although to a less extent. The advent of high-deductible policies has made deciding to go to the doctor a more thoughtful exercise.

Technology

The technology is perhaps the most volatile of all the sectors. Young companies rise and fall with alarming frequency. Major players such as Apple and Microsoft are more stable investments, however even these giants feel the effects of a shifting technology and consumer demands.

Transportation

Companies involved in the movement of goods and people make up the transportation sector. These include airlines, trucking and railroads. The price of fuel and the relative health of the economy are important factors.

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