What is sector and industry analysis, and how retail investors can do the sector and industry analysis to make better investment decisions?
One of the most important aspects of investing in the equity market is sector and industry analysis.
However, retail investors seldom analyze the sector or the industry. So, in my opinion, it is one of the main reasons that retail investors tend to make fewer returns than HNI Investor or High Networth Individual investors.
So for today, we will see what is sector and industry analysis in general and how we retail investor can go about doing it and generate better returns for our investment in the market.
What is Sector Analysis?
Assessing the future growth potential of a given sector of the economy is termed sector analysis. It is a way to be able to judge how companies in a sector will perform.
There are two approaches in the market – Top-Down and Bottom-Up Approaches.
In the top-down approach, the sector analysis is high up the order to decide on the investment.
Sector analysis works well in the market because business work in cycles.
A business will have a growth face where there will be significant demand. Because of the demand, there will be supply coming to the market to serve the higher demand. As supply peaks, the demand moderates, and the business gets into the lull phase.
The above cycle continues for specific sectors, and such sectors are known as cyclical. Steel, Cement, Paper etc., are examples of a few cyclical sectors.
Then we have some ever-growing sectors where the demand keeps on at a moderate pace. Examples of such sectors are Paints, Apparels, Banking, FMCG (Fast-moving consumer goods), FMEG (Fast moving electrical goods) etc.
What is Industry Analysis?
Industry analysis is a specialisation of sector analysis. In other words, Sector analysis is a general analysis of the industry as a whole.
I am sure you are getting a spin in your head now but believe me, it is not as tricky as I may have expressed it in words above.
So let me explain it with an example. For example, Suppose one wants to invest in a chemical sector. In that case, it is better to look for industry within it like Agro-chemical (PI Industries) or Specialty chemical (Fine Organics) etc.
Another example could be Steel. Once you consider the steel sector, the analysis of the different forms of steel (Long Products) or even the steel sector’s supply chain can be termed the industry analysis.
How to do Sector and Industry Analysis
Sector and industry analysts need to go through a few companies’ annual reports within the same sector or industry.
For example, Bosch is a peer of Amara Raja Batteries and MRF because both manufacture automotive parts. So going through the annual reports of each peer group company can give us insights about the auto-parts as a sector.
However, if one wants to invest in a company, the industry analysis will be more critical because it helps understand factors like companies operational efficiency among peers, entrants of new players, threats to the current business as well as growth opportunities. So going through the annual reports of Exide and Amara Raja can help us understand the battery industry within the auto-component sector.
The auto sector may do well, but the batteries segment may not do well because of the EV.
In the annual reports, there is always a sectorial and industry view to help investors. However, when you are reading forward-looking statements from the management, make sure to see how well they have lived up to the promises they have made in the past reports.
Each sector can have various industries under them. Once you can identify the right sector to invest in, it is essential to understand the industry within the sector that will outperform.
Since the unlock started in 2020, there was a stage of good performance of Pharma. Then we had the IT and metal sector outperforming. In the past two years, the hospitality sector has underperformed. Then we have evergreen sectors like FMCG and Paints.
Some sectors will perform better than others at different stages of the business cycle. So one should learn to identify sectors that will outperform to make intelligent investment decisions.