Using Stock Sectors to Categorize Stocks
The stock market classifies stocks in different ways, such as by type of business. Companies in similar industries are grouped together for comparison purposes. Most analysts and financial media call these groupings “sectors,” and you will often read or hear about the performance of certain stock sectors.
One of the most common classifications breaks the market into 11 different sectors. Investors commonly consider two of these sectors “defensive” and the remaining nine “cyclical.” These two categories have different meanings for the individual investor.
The Defensive Sectors
Defensive stocks include the Utilities and Consumer Staples sectors. Companies in these sectors usually don’t suffer as much in a market downturn because people don’t stop using energy or eating. These stocks can provide a balance to portfolios and offer protection in a falling market.
However, for all of their purported safety, defensive stocks usually fail to climb with a rising market for the opposite reasons that they provide protection in a falling market: in good times, people don’t use significantly more energy or eat significantly more food.
Defensive stocks do what their name implies, assuming the stocks belong to well-run companies. These shares can give you a cushion for a soft landing in a falling market.
Cyclical stocks cover everything else not included in the two previously-mentioned sectors and tend to react to a variety of market conditions that can send them up or down. These sectors can move independently of one another, and when one sector goes up another may be going down.
The following nine sectors include stocks for companies in generally cyclical industries
- Basic Materials
- Capital Goods
- Consumer Cyclical
- Health Care
Most of these sectors are self-explanatory. They all involve business types that you can readily identify, and investors call them cyclical because they tend to move up and down in relation to business cycles and other influences.
Basic materials, for example, include those items used in making other goods, such as lumber. When the housing market is active, the stock of lumber companies tends to rise. However, high interest rates might put a damper on home building and subsequently reduce the demand for lumber and the associated stock prices.
How to Use This Knowledge
You can use stock sectors as helpful sorting and comparison tools. Don’t get hung up on using just one organization’s set of sectors, though. MorningStar.com uses slightly different sectors in its tools, and you can compare stocks within a sector, among other analyses.
Analyzing stocks by sector has become extremely helpful since the sector information makes it much easier to compare how your stock or a stock you may want to buy is doing relative to other companies in the same sector.
Sector analysis can highlight the fact that, for example, all the other stocks are up 11 percent and your stock is down 8 percent, and you would want to find out what's driving this difference.
Likewise, if the numbers are reversed, you would want to know why your stock is doing so much better than others in the same sector. Perhaps it has changed its business model, or some other change has rendered it a poor fit for that sector.