Industry Alphabet Soup: Decoding the Identifiers

1. SIC GICS NAICS Industry Alphabet Soup:Decoding the Identifiers Jay ReingoldVice President, Library ServicesMay 2, 2003

2. Agenda • Industry Classification - An approach to the problem. • How can we classify industries? • Who needs to classify industries? • SIC and NAICS codes: • History, applications, limitations • S&P/MSCI Global Industry Classification Standard (GICS): • History, applications • Cracking the code: What system should we use?

3. Q 1. What is an industry? A. A group of firms that share some type of economic relatedness. (JR) Question 1A: So what does that mean?

4. Potential Industry Parameters “Economic Relatedness” could mean: • Similar production methods • Similar products • Similar services rendered • Similar inputs / raw materials • Similar customers • Similar stock performance • We can develop industry classification systems along any of these parameters. Challenge is identifying the right system for the right purpose or mode of inquiry.

5. Who cares about industry classification and why? Government: How is the economy structured? What industries are growing / declining? Where are jobs being created? Businesses: Who are my competitors? Who are my potential customers? How big is my market? How do I evaluate credit risk? Investors: What is the sensitivity of my portfolio or an investment to industry factors? How do I hedge industry risk? How do I overweight or underweight a particular industry in my portfolio? Can a single classification system help us answer all of these questions?

6. Standard Industry Classification (SIC) • Developed in late 1930s as the standard industry classification of the US Government. Last revised in 1987. • Designed to facilitate the collection, calculation, and dissemination of economic statistics. • “Establishment” oriented system - seeks to classify primary business activity within a specific physical establishment. • 4-digit numeric code. • Quickly adopted as the standard. Was widely used by professionals from both the business and the academic world.

7. Standard Industry Classification (SIC) • By the 1990s, the dissatisfaction with the SIC began to mount as the shortcomings of the system came into clearer focus: • No consistent philosophy underlying the design of the system - some classifications were production-based and some product-based (Greeting Cards vs. Printing). • 4-digit system lacked flexibility, was not reflective of new service and high-tech economy. • Difficult to align SIC codes with international industry classification systems in order to gain a global view on industries.

8. North American Industry Classification System (NAICS) • Adopted by Office of Management and Budget (OMB) in 1997 to replace SIC. • NAFTA prompted need to develop a North American solution in cooperation with Canada and Mexico. • Production-oriented classification scheme. Groups firms with similar manufacturing or service processes together. • Service firms and high tech firms better represented (250 out of 358 newly recognized industries are service oriented).

9. North American Industry Classification System (NAICS) • NAICS is a six-digit system, provides for more granular classification: • Sector 51 Information • Sub-Sector 511 Publishing • Group 5111 Newspaper, Book & Database Publisher • Industry 51111 Other Publishers • US National Industry 511191 Greeting Card Publishing • 66% of 4-digit SIC codes map directly to NAICS. • Compatibility between 2-digit NAICS and 2-digit ISIC codes.

10. North American Industry Classification System (NAICS) Who’s happy? Economists: NAICS facilitates more precise and descriptive calculation of the components of GDP. Marketers: Better able to target emerging industries and service companies. Businesses: Production-based system enables companies to measure creditworthiness of businesses more accurately (Firms within NAIC industries more likely to carry a similar amount of debt).

11. North American Industry Classification System (NAICS) • Who’s unhappy? Investors and financial professionals. • NAIC codes are “source dependent” - the NAIC code assigned by OSHA may differ from that assigned by S&P Compustat, CRSP, OMB etc. • NAICS is a North American schema not a global schema. • NAICS classifications do not seem to correlate with stock returns - the market is viewing/classifying industries in a different way.

12. Needs of the Financial Community • A single, consistent company classifications system to support asset allocation, portfolio analysis and research. • A global classification system - capital markets are almost fully integrated. • Stronger correlation between industry classification and stock performance for risk management and portfolio construction purposes.

13. The Global Industry Classification Standard (GICS) • Industry classification system specifically designed for financial professionals. • Developed in 1999 by Standard & Poor’s and Morgan Stanley Capital International (MSCI), two leading providers of global indexes. • Officially launched on January 2, 2001 as the industry classification scheme underlying the S&P 500. • Over 25,000 companies, globally, have been GIC’ed.

14. GICS Methodology: Code Assignment • MSCI and S&P jointly assign a single GICS sub-industry code to a company according to the definition of its principal business activity. • Principal business activity is generally defined by revenues. Earnings analysis and market perception (i.e. Wall Street’s view) are also important criteria for classification. • Annual review (at minimum) is conducted to ensure that the GICS classification code is accurate. • Corporate actions also prompt GICS code review.

15. The Global Industry Classification Standard (GICS) • 4 Levels of detail: • 10 Sectors • 24 Industry Groups • 62 Industries • 132 Sub-Industries • *As of April 30, 2003.

16. The Global Industry Classification Standard (GICS) • A GICS code is a 2- to 8- digit code that will define each of the four levels where a company is classified: • GICS Sector: first 2 digits • GICS Industry Group: first 4 digits • GICS Industry: first 6 digits • GICS Sub-Industry: all 8 digits • Example: • Industrials Sector: 20 • Capital Goods Industry Group: 2010 • Machinery Industry: 201060 • Construction and Farm Machinery Sub-Industry: 20106010

17. The Global Industry Classification Standard (GICS) • GICS four-level design satisfies diverse investment and research needs: • The Sector level breaks down the entire market into a broad economic picture, which becomes useful for such products as Sector score-cards and Sector ETFs. • Industry Group and Industry classifications have proven useful in risk analysis, return attribution, and profitability trends. • Sub-industry groups enhance the ability to measure sector exposure and peer-group analysis in investment portfolios.

18. The Global Industry Classification Standard (GICS) A recent Cornell study has demonstrated that GICS based industry means explain a greater proportion of variation in . . . • Cross-sectional firm-level stock returns. • Firm-level P/B, Enterprise Value / Sales, and P/E ratios than industry means constructed around NAICS or SIC codes. • Firm-level financial ratios: ROA, ROE, Asset Turnover, Net Margin. Source: Bhojraj, S., Lee, C. M. C.; Oler, D. “What’s My Line? A Comparison of Industry Classification Schemes for Capital Market Research.” Working Paper. Cornell University. November, 2002

19. Cracking the Code To conclude . . . • NAICS and GICS can happily coexist. • NAICS system is terrific for economic and business research applications. • GICS much more appropriate for finance and investment research. • Both systems are easily accessible to students and reference librarians.

20. For more information . . . • Visit the following websites: • www.census.gov • www.naics.com • www.standardandpoors.com

21. Thank you • Jay Reingold • Vice President, Library Services • Standard & Poor’s • email: jay_reingold@standardandpoors.com • tel. # (212) 438-3688