GICS vs. ICB Stock Classification: An Overview
Understanding how sectors are defined is critical to diversifying a stock portfolio. That said, there are two competing systems for classifying stocks into sectors and industries: the Global Industry Classification Standard (GICS) and the Industrial Classification Benchmark (ICB).
Both were designed to provide an accurate and standardized industry definition for use by the global investment community. The differences are minor and, in any case, the investor often doesn't make the choice. All of the major indexes have adopted one or the other as their standard.
Both of these classification systems are intended to provide an industry and sector framework that enables accurate research, portfolio management, and asset allocation. Their international scope allows for meaningful comparisons between sectors and industries worldwide.
In practice, most of the same sector and industry designations exist in both standards and most major companies globally are classified under both systems.
- A stock's price tends to move up or down in response to trends that impact an entire sector or industry.
- An investor who seeks a diversified portfolio needs to know how a stock is classified by sector and industry.
- The GICS and the ICB are two rival systems for classifying stocks according to the goods or services that they produce.
There are two approaches to assigning companies to industries: a production-oriented approach and a market-oriented approach.
A production-oriented approach defines companies according to what they produce. A company that manufactures a tool would be classified differently than a company that offers a consulting service, even if both are sold in the same marketplace. Of course, many companies offer both goods and services, so the line has become blurred.
GICS takes the market-orientated approach. The distinction between consumer goods and services has been replaced with the more market-oriented sectors of consumer discretionary and consumer staples, both of which contain both goods and services companies.
Consumer staples companies sell products and services that are considered necessities and thus are unlikely to be severely harmed by an economic slowdown. That makes them part of a non-cyclical sector. Supermarkets are an example.
Consumer discretionary companies produce goods and services that are not necessities and thus tend to be hit hard by an economic slowdown. Automobile manufacturers, restaurants, and hotels are on this list. The consumer discretionary sector is considered a cyclical sector.
Consumer staples are necessities and are unlikely to be harmed by an economic slowdown. Consumer discretionary products tend to be hit hard by a recession.
The GICS classification system consists of four levels. As of 2020, there were 11 sectors, 24 industry groups, 69 industries, and 158 sub-industries. (Note: The titles and numbers change periodically.) The 11 sectors are:
- Consumer Discretionary
- Consumer Staples
- Information Technology
- Real estate
- Communication Services
A company is assigned GICS classification codes at the sub-industry levels by Standard & Poor's and MSCI according to their definition of the company's principal business.
A company's main source of revenue is the most important factor in determining its principal business activity. Other factors, such as earnings analysis and market perception, are also considered.
The Global Industry Classification Standard (GICS) was developed jointly by Morgan Stanley Capital International (MSCI) and Standard & Poor's (S&P) in 1999.
The ICB uses a four-tier structure with industry, supersector, sector, and subsector levels. Developed jointly by Dow Jones Indices and the FTSE Group in 2005, the ICB is now owned solely by FTSE. The ICB uses a system of 11 industries partitioned into 20 supersectors, which are further divided into 45 sectors, which then contain 173 subsectors. (Note: These numbers are subject to change.) As of 2020, the 11 industries are:
- Real Estate
- Consumer Discretionary
- Consumer Staples
- Basic Materials
The ICB system allocates each company to the subsector that most closely describes the nature of its business. When a company conducts two or more types of business that differ substantially, the predominant sector is determined by a review of the audited accounts and the directors' report.
Companies may be classified on the basis of either the immediate or the end use of the product, or the industrial process used.
Special Considerations on Stock Classification
A stock's classification is key to an investor whose aim is a diverse portfolio. Stocks tend to move up or down based on underlying factors that impact entire industries. If a stock's price bucks the industry trend up or down, that is just as important to know.
One of the basic methods for understanding the risk of an investment portfolio is to determine its sector breakdown. Is the portfolio spread across various industrial sectors or concentrated in just a few? This provides a good indication of how an investment portfolio will respond to macroeconomic factors or industry trends.
Sector composition is also crucial for a sector rotation strategy. The investor following this strategy moves money among various sectors depending on a short-term view of the outlook of each. The investor overweights sectors likely to outperform and underweights those expected to underperform.
Understanding an industry is helpful when valuing any of the companies assigned to it. In some industries, cash flow or EBITDA might be more relevant than earnings. It is not a coincidence that equity research analysts generally cover companies in a single industry.
Comparing ICB and GICS
The ICB and GICS systems are not really all that different.
The greatest difference lies in how consumer businesses are classified at the sector level. With the ICB, companies doing business with consumers are divided into providers of goods and providers of services. With the GICS, companies are labeled as cyclical or non-cyclical, or between discretionary spending and staples.
At the lower levels, there are more differences, but their impact is not hugely significant. For example, in the ICB, coal companies are found in basic materials, but under the GICS these companies are classified in energy.
Whether one of the systems is superior is a matter of preference. The end user does not really have a choice anyway, as all of the major indexes associate their listed stocks with one or the other.
One note, though: if diversification is a goal, investors using sector exchange-traded funds (ETFs) should choose funds that are all part of the same family and use the same underlying classification scheme.