What If Sector Classification Is All Wrong?

The Global Industry Classification Standards (GICS) classify industries into eleven different sectors and do so on a purely intuitive rather than a data-driven basis. But once you look past that intuitive level, the sectors make no sense. What do Cigna and Amgen have in common, really? Yes, they’re both in the business of “health care.” But as businesses go, they couldn’t be more dissimilar. What does a semiconductor manufacturer have in common with an IT consulting service? They’re both in “technology,” but I can’t think of anything else. What does an airline, a defense contractor, a manufacturer of electrical equipment, and a human resources firm have in common? They’re all “industrials.” But they operate in completely different ways, and the market knows that very well.

So I started wondering if there were a better way to classify industries than by using GICS sectors. There are several ideas out there.

One is to use “themes.” Portfolio123 classifies all industries into five themes: macroeconomic (most industrials, transport, discretionary, most materials), population growth (staples, some health care, communications, utilities), special (energy, precious metals, airlines), financial (banks, insurance, real estate), and innovative (biotech, pharma, tech). This makes intuitive sense, but almost all of the GICS sector classifications (with the exceptions of materials, industrials, and health care) remain intact, so it’s more like a grouping of sectors than an attempt to rethink them altogether.

Some folks at Open Matters, a machine learning company, suggest that we classify companies according to whether they’re asset builders (make and sell physical things), service providers (use people to offer services), technology creators (generate and deliver intellectual property), or network orchestrators (facilitate transactions and interactions). I like this idea, but I haven’t seen anyone follow up with it and actually classify companies in this way. A similar idea, suggested to me by an RIA on a Portfolio123 forum, is to classify industries in five groups: input resources, business-to-business, business-to-consumer, infrastructure and government, and facilitators.

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Disclosure: My top ten holdings right now: ARC, PCMI, GSB, RLGT, CTEK, PERI, PFSW, NTWK, CLCT, PDEX. CAGR since 1/1/16: 41%.

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