The ecosystem is dynamic and involves so many things and when it comes to investing, one of the most important steps that should be taken into consideration before we invest in any stock is, Stock Analysis. After all, you should always invest some time in analyzing a stock before you invest money in it. In the process of stock analysis, in a broader sense, analyzing the sector is a factor that is significant.
- What Is a Sector?
A sector is an area of the economy in which businesses share the same or related business activity, product, or service. Sectors represent a large grouping of companies with similar business activities, such as the extraction of natural resources and agriculture.
Dividing an economy into different sectors helps economists analyze the economic activity within those sectors. As a result, sector analysis provides an indication as to whether an economy is expanding or if areas of an economy are experiencing contraction.
In the financial markets, economic sectors are broken down even further into sub-sectors called investment sectors. Investment sectors represent a grouping of companies with similar business activities. Examples of investment sectors include technology, energy, and financial services.
This article explores the main types of economic sectors and the business activity associated with them, and how investment sectors play a role in determining a nation's economic conditions.
- What is Sector Analysis?
Assessing the economic and financial condition of a given sector of the economy is termed as sector analysis. It provides an investor with a judgment about how efficiently companies in the sector can perform. It also helps in picking some under performers.
Sector analysis is employed by investors who are specialized in a particular sector, or who use a top-down or sector rotation approach to investing.
Sector analysis is based on the assumption that during different stages of business cycle certain sectors perform better.
The business cycle is comprised of expansions which are periods of economic growth, and contractions, which are periods of economic decline.
During the expansion phase, investors or analysts who do a sector analysis would focus their research on companies that benefit from low interest rates and increased Capex.
For example companies in the financial and consumer discretionary sectors performance increases during the periods of economic growth.
When, the economy contracts and growth slows, Investors and analysts will turn their attention to research defensive sectors, such as utilities and telecommunication services as these sectors often outperform during economic downturns.
- Importance of Sector Analysis
It is very important to analyse an Sector before you invest in any stock from it because that way you get to understand the macroeconomic factors that can affect your chosen stock. There are multiple reasons why Sector analysis is important as it lets you:
- Identify the best investment opportunities
- Understand how an Sector works
- Evaluate future prospects of the stock as well as the sector as a whole.
- Advantages of Sector & Industry Analysis
Report that is prepared under industry and sector analysis helps to assess the future prospects of the company.
Both the analysis helps to forecast the actions taken up by potential competitors.
With the help of analysis report we are able to recognize and identify strategies that will improve the effectiveness of the particular sector as well as industry.
They are the tool to develop a competitive strategy that will act as the best defense against potential competitors.
One sector can have various industries under them for example an Auto Sector might have many Industries like casting, forging, auto ancilliary, battery etc thus a Sector analysis will help to understand that which Industry from this sector will likely outperform.
- Disadvantages of Sector & Industry Analysis
Seasonal factors have a direct impact on the purchase and sale patterns of the companies of any Industry. If these factors are not considered then it may act as a limitation in a report.
If in any year any economic or macro headwind like corona occurs then the Industry may behave against the analysis.
Thus sector & industry analysis is subjective and does not guarantee success but knowing the Sector first and then finalizing the Industry may also not play out well and there one might have to do a bottom-up analysis. That is analyzing Industry first and then Sector.