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Subject 2. Approaches to Identifying Similar Companies PDF Download
There are three main approaches to classifying companies:

  • Products and/or service supplied. This is the main approach to industry classification. Companies are categorized based on the products and/or services they offer. The term "sector" is used to refer to a group of related industries.

  • Business-cycle sensitivities. A cyclical industry is sensitive to business cycles. Its revenues are generally higher in periods of economic prosperity and lower in periods of economic downturn. The performance of a non-cyclical industry is independent of the business cycle.

    Non-cyclical industries can be sorted into two categories:

    • A defensive (or stable) industry demonstrates stable performance during both economic expansion and contraction.
    • Companies in a growth industry achieve above-normal growth rates and profitability at any stage of the general business cycle.

    However, there are limitations when using these industry descriptors. For example, some industries may include both growth companies and defensive companies.

    Note two things:

    • Business-cycle sensitivity is a continuous spectrum.
    • A global company can experience economic expansion in one part of the world while experiencing recession in another part.

  • Statistical similarities. Statistical cluster analysis is defined as the art of finding groups in data such that the degree of natural association is high among members within the same class (internal cohesion) and low between members of different categories (external isolation). This technique can be used to categorize companies into different industries.

Learning Outcome Statements

b. compare methods by which companies can be grouped, current industry classification systems, and classify a company, given a description of its activities and the classification system;

c. explain the factors that affect the sensitivity of a company to the business cycle and the uses and limitations of industry and company descriptors such as "growth," "defensive," and "cyclical";

d. explain how a company's industry classification can be used to identify a potential "peer group" for equity valuation;

CFA® 2021 Level I Curriculum, 2021, Volume 5, Reading 40

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