Investment Banking: How to Create a Comparison Universe for an Industry Analysis - dummies

Investment Banking: How to Create a Comparison Universe for an Industry Analysis

By Matt Krantz, Robert R. Johnson

The first part of an investment banker’s industry analysis is to define which companies are to be included in the universe. So, before you can start doing some serious analysis of the industry, you have to define what the industry is and who the big players in it are.

Picking the correct companies to include in the comparison universe is important since the mix can have a big sway on the conclusions reached. Putting companies into categories used to be more difficult, but the development of classification systems and the decreased role of hard-to-classify conglomerates has made the job much easier.

Conglomerates are large and widely diversified companies that oversee a collection of somewhat unrelated businesses. Conglomerates were very popular in the 1960s, because low interest rates allowed companies to scoop up businesses using borrowed money.

Conglomerates were a way for investors to diversify their portfolios, before the creation of index mutual funds, which spread investors’ risks over dozens of stocks. But since the 1960s, conglomerates fell out of favor, with General Electric and Warren Buffett’s Berkshire Hathaway being two of the most famous survivors.

There are several ways that investment bankers are able to generate their universes to compare with. Building the list takes quite a bit of research and may require you to consider different companies, and perhaps toss them out of the universe if you decide they’re not applicable.

The Global Industry Classification Standard

Finding all the players in an industry may seem overwhelming, but much of the work may be done for you.

There’s a massive industry organization system called the Global Industry Classification Standard (GICS), which groups companies much like zoologists have a way of organizing similar animals. Just as animals are placed into a genus and species, companies are put into sectors and industry groups. GICS was developed by investment professional firms Morgan Stanley Capital International (MSCI) and Standard & Poor’s to assist in the analysis of companies.

Individual investors often confuse sectors and industry groups, but they’re actually quite different ways to look at groups of companies. Sectors are broad categories that roll up a number of relevant industry groups. Industry groups can be then further sliced into individual industries.

There are ten sectors, or main groupings that categorize all the major areas of businesses. Those ten sectors are then broken down into 26 industry groups. And those 26 industry groups break down into 70 industries.

Sector Select Industry Groups Select Industries
Energy Energy Energy Equipment and Services, Oil, Gas, and Consumable
Fuels
Materials Materials Chemicals, Construction Materials, Containers and
Packaging
Industrials Capital Goods Aerospace and Defense, Building Products
Commercial and Professional Services Professional services
Transportation Airlines, Road and Rail
Consumer Discretionary Automobiles and Components Auto Components, Automobiles
Consumer Durables and Apparel Household Durables, Leisure Equipment
Retailing Distributors, Internet and Catalog Retailers
Consumer Staples Food, Beverage, and Tobacco Beverages, Food Products
Household and Personal Products Personal Products
Healthcare Healthcare Equipment and Services Healthcare Equipment and Supplies
Pharmaceuticals, Biotechnology, and Life Sciences Biotechnology, Life Sciences and Services
Financials Banks Commercial Banks, Thrifts and Mortgage Finance
Diversified Financials Diversified Financial Services, Consumer Finance, Capital
Markets
Information Technology Software and Services Internet Software and ServicesIT Services
Technology Hardware and Equipment Communications Equipment, Computers and Peripherals
Telecommunication Services Telecommunication Services Diversified Telecommunication Services, Wireless
Telecommunication Services
Utilities Utilities Electric Utilities, Gas Utilities, Water Utilities

Source: MSCI, S&P Capital IQ

Here’s an example: Let’s say you wanted to look into the investment banking industry. It turns out that the Investment Banking and Brokerage sub-industry is a member of the Capital Markets industry. The Capital Markets industry is a part of the Diversified Financials industry group, which is part of the Financials sector.

When you figure out which sector and industry group the company you’re studying belongs in, you can get a good start on your industry universe.

See who companies say their rivals are

If anyone knows who a company’s competitors are, it’s the company’s management team. Companies in the same industry are intensely competitive with one another. And you can be sure they know which companies are trying to steal business from them.

For a variety of reasons, companies don’t like to talk publicly about their competitors very often. But investment bankers paying close attention to the regulatory filings will see that, from time to time, companies may name firms they consider to be competitive, at least with part of their business. These lists of competitors may be named in the company’s 10-K or 10-Q.

Another treasure trove of competitive information comes when a company in the industry files to sell shares to the public in an initial public offering (IPO). In the IPO prospectus (a document that a company selling securities provides to interested investors that describe the investment), the company’s investment bankers are required to disclose a list of all the companies that are considered competitive.

Check out the peers from which boards of directors set CEO pay

If there’s one area in which CEOs don’t want to slip behind their competition, it’s their own pay. Each year, companies’ boards of directors determine how much to pay the CEO and other top management. It’s a much-watched process that many investors pay attention to.

But more important to investment bankers than the amount being doled out to the CEO is the process used to determine the pay. Companies pay close attention to the other companies in the industry, and in the process, they do much of the industry analysis for investment bankers.

For investment bankers, the part of the proxy statement that shows the universe of companies with which a company compares CEO pay is priceless.