Sector Analysis: Definition, Framework, Factors, How to do it

Sector analysis is a vital tool for investors and companies to evaluate different segments of the economy and identify opportunities for outperformance. It involves analyzing entire industries and economic sectors to determine growth trends, competitive landscapes, and prospects relative to the overall market. 

Conducting thorough sector analysis allows investors to tilt their portfolios towards areas with strong potential and helps businesses make strategic decisions. Analysts examine both qualitative factors, such as economic conditions, regulations, and demographic shifts, as well as quantitative metrics, such as historical financial performance and valuation ratios. The goal is to pinpoint sectors that are well-positioned for expansion based on their positioning in the business cycle and macroeconomic environment. 

Key approaches to sector analysis include top-down frameworks focusing on macro trends and sector rotation strategies targeting industries in early growth phases. A comprehensive evaluation of sectors guides investment decisions and capital allocation to maximize returns over full market cycles.

What is sector analysis?

Sector analysis is the process of evaluating different sectors of the economy to determine their performance and outlook. Sector Analysis involves analyzing entire industries and sectors rather than individual companies. The goal is to identify sectors that are likely to outperform the overall market, as well as those that sometimes underperform. To conduct sector analysis, analysts examine both qualitative and quantitative factors.

Qualitative factors include economic, regulatory, and demographic trends that impact a sector. Quantitative analysis looks at historical financial performance and valuation metrics. Analysts also evaluate the sector’s position in the business cycle. Sectors in the early stages of expansion often offer the most potential. Sector analysis aims to identify the sectors best positioned for growth, allowing investors to tilt their portfolios towards areas of strength in the economy. It provides a macro perspective on the markets rather than just looking at individual stock fundamentals.

How does sector analysis work?

Sector analysis works by examining different sectors of the economy, such as technology or healthcare, and determining which sectors are likely to outperform or underperform the market during different stages of the business cycle, allowing investors to adjust their portfolios accordingly.

By analyzing different sectors, investors identify industries and companies that are poised to outperform or underperform the broader market based on where we are in the business cycle. The business cycle refers to the cyclical expansions and contractions of economic activity. The cycle consists of four main phases – expansion, peak, contraction, and trough. During the expansion phase, economic activity accelerates as production and demand increase. This leads to strong growth in GDP, falling unemployment, and rising corporate profits. The peak marks the transition point between expansion and contraction. Economic activity hits its maximum sustainable level at the peak before beginning to slow down. 

The contraction phase consists of declining economic activity as production, demand, and corporate profits begin to fall. GDP growth turns negative, unemployment rises, and the economy enters recession. Finally, the trough marks the end of the contraction when economic activity hits its lowest point before starting to recover again.

What is the objective of sector analysis?

The main objective of sector analysis is to help businesses or investors make informed decisions by providing insights into market demand, competition, opportunities, threats, and trends in order to devise strategies that capitalize on strengths while addressing weaknesses. There are eight key goals of performing sector analysis. At its core, sector analysis guides critical business and investment choices by providing insights into industry dynamics.

Investors leverage sector research to identify promising areas to allocate capital based on growth prospects. It also steers stock selection by revealing well-positioned companies. For businesses, sector insights direct high-level strategic decisions on new market entry, partnerships, competitor responses, and resource allocation. Analyzing sectors allows investors and companies to map out the competitive landscape. Researching companies within a sector helps pinpoint direct and indirect competitors. This is critical for evaluating relative competitive positioning and strengths vs. weaknesses.

For investors, competitive analysis highlights which companies are poised to outperform. More granular competitor analysis enables assessing the relative strengths and weaknesses of companies in a sector. For instance, benchmarking financials, market share, branding, operational efficiency, and other differentiators between rivals. These insights help forecast which competitors are most threatening or which are vulnerable.

Thorough research into sector conditions helps build projections for demand and supply trajectories. By analyzing macro factors like consumer spending, costs, regulations, and technological changes, investors and firms forecast future demand and supply. This guides decisions on which sectors or companies to focus on.

What are the types of sector analysis?

There are two main types of sector analysis used in stock marketing – the top-down approach and the sector rotation approach.

1.Top-down approach

The top-down approach is one of the main methods used in sector analysis for stock marketing. This method takes a macro view of the overall economy and markets to determine which sectors are likely to outperform. The goal is to identify the best sectors to invest in based on current economic conditions and future projections. 

The first step is to analyze the broad macroeconomic environment when using a top-down sector analysis approach for stocks. This includes looking at leading indicators such as GDP growth, inflation, interest rates, employment rates, manufacturing activity, and consumer sentiment. The analysts will assess the current state of the economy and where they believe it is headed in the near future. Strong economic growth typically benefits cyclical sectors such as technology, consumer discretionary, financials, industrials, and materials. Meanwhile, weaker growth tends to favor defensive sectors like healthcare, consumer staples, and utilities. 

Beyond macroeconomics, top-down analysis also considers the phase of the business cycle the economy is in. Early cycle phases tend to favor cyclical stocks as the economy recovers from recession. Mid-cycle phases benefit a mix of cyclical and defensive stocks as the recovery matures. Late cycle phases favor defensive stocks as growth moderates ahead of the next recession. Understanding the business cycle is key to positioning sectors properly.

Top-down analysts will also evaluate fiscal and monetary policy since government spending, taxes, and central bank actions all impact the economy and markets. For example, fiscal stimulus and lower interest rates tend to boost cyclical sectors, while austerity measures and tighter monetary policy tend to favor defensive sectors.

At the market level, top-down analysis looks at the relative performance between stocks, bonds, and cash. Stocks outperforming suggest a prevailing risk-on sentiment, benefiting cyclical sectors. Strong bond performance indicates risk-off sentiment, which tends to favor defensive stocks. 

Beyond macroeconomics and markets, top-down analysis also looks at trends by sector and industry. The goal is to identify sectors with superior growth prospects, earnings momentum, valuations, and price performance. This analysis points to sectors that are best positioned competitively regardless of the macro environment. For example, sectors undergoing technological disruption and innovation often outperform even in weaker economies.

Top-down research draws from a variety of macro data sources and research reports. Key sources include the Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve, Conference Board, purchasing manager indexes, Corporate Earnings Outlooks, and proprietary bank research. 

The top-down analysis yields a sector framework for equity investments based on macro trends, the business cycle, fiscal and monetary policy, market performance, and sector dynamics when it is completed. Institutional investors begin their equity strategy with a top-down sector framework as the foundation before selecting individual stocks.

A top-down approach offers key benefits in sector analysis for stock marketing. It provides a big-picture view of markets based on objective data. This technique avoids subjective biases that arise from focusing only on bottom-up company-specific details. The macro focus allows investors to tilt their portfolios towards favored sectors during different parts of the business cycle. Dynamic sector allocations based on top-down research potentially enhance portfolio returns over time.

The top-down approach also has limitations. Sector investing based on macro trends will lag in fast-changing conditions. There is still room for subjectivity based on one’s macro outlook. It also provides little input on selecting specific stocks within favored sectors. Risks are mitigated by combining top-down sector analysis with bottom-up stock analysis. 

2. Sector rotation approach

The sector rotation approach is another key method used in sector analysis for stock marketing. This tactical approach involves shifting investment holdings between different sectors and asset classes to take advantage of the business cycle. The goal is to rotate into sectors that are early in their expansionary phase and poised to outperform the broader market.

A sector rotation strategy recognizes that sector performance is cyclical in nature. As economic expansion matures, early cycle sectors like technology, industrials, and materials will eventually underperform. Meanwhile, defensive sectors like utilities, healthcare, and consumer staples tend to take the lead. By rotating between sector categories at different stages of the cycle, investors aim to enhance returns.

The typical sector rotation framework divides the eleven stock market sectors into three categories – early cyclicals, late cyclicals, and defensives. Early cyclical groups include technology, materials, industrials, and consumer discretionary. Late cyclical sectors are energy, financials, and real estate. The defensive sectors are utilities, consumer staples, telecom, and healthcare.

Investors rotate their stock holdings counter-clockwise through these three stages. Early cycle recovery phases favor early cyclical. Mid-cycle expansionary phases benefit late cyclical. Late cycle slowdown phases warrant increased exposure to defensive sectors. This rotation aims to capture sector leadership as the business cycle evolves.

A sector rotation strategy relies heavily on economic indicators to gauge the phase of the business cycle. Important indicators include GDP growth, yield curve, inflation, consumer sentiment, employment data, and housing starts. The strategy involves increasing exposure to early cyclicals when growth is accelerating out of recession. As the expansion matures, positions rotate from early to late cyclical. In the late cycle, defenses take precedence to protect against impending recession. 

In addition to economic data, sector rotation analysis incorporates earnings momentum and relative price strength. Sectors delivering upside earnings surprises and stronger technical momentum often sustain outperformance. These stock selection factors are integrated along with macrocycle analysis.

Investors utilize a variety of tactics to implement a sector rotation strategy. This includes overweighting favored sectors, underweighting or avoiding lagging groups, and shifting between cyclical and defensive stocks. Exchange-traded funds across sectors offer an efficient vehicle to execute rotations. Individual stocks are also used, focusing on sectors with the most positive momentum.

As with any dynamic investment strategy, sector rotation requires actively monitoring macro, fundamental, and technical trends. Frequent rotation must be balanced against trading costs. Rotating too often leads to churn without meaningful gains. Allowing cycles to evolve substantively reduces turnover.

A sector rotation approach aims to enhance portfolio returns over a full market cycle. However, the strategy also has limitations. Predicting economic turns is challenging, leading to potential mistiming of rotations. Sectors diverge from typical cyclical patterns. Moreover, major bull and bear trends override normal rotational leadership. Despite flaws, simulated evidence still suggests rotation incrementally boosts performance.

What are the factors of sectoral analysis?

Key factors in sector analysis include PESTLE elements like politics, economics, society, technology, law, and environment, as well as size, age, focus, substitutes, and other forces shaping industry competition and attractiveness.

PESTLE framework

The PESTLE analysis evaluates the overall macro-environment surrounding a sector to assess its investment potential. It specifically looks at political, economic, social, technological, legal, and environmental factors. This top-down perspective provides crucial context on the external forces that influence industry performance. Equity analysts leverage PESTLE analysis to determine which sectors are best positioned given the current operating backdrop. 

Political Factors

The political environment has major ramifications on sector and industry prospects. Analysts assess political stability, policies, and regulatory changes that impact competitiveness. Key areas include tax policy, trade policy, government spending, election cycles, and regulatory bodies. For example, increased infrastructure spending would benefit the engineering, construction, and raw materials sectors. Meanwhile, stricter environmental regulations hurt fossil fuel-related sectors. 

Economic Factors 

The overall health of the economy is a critical driver of equity sector performance. Analysts thoroughly assess economic indicators, including GDP growth, inflation, interest rates, credit conditions, currency values, disposable income levels, and unemployment rates. Times of strong economic expansion support cyclical sectors like industrials, financials, and consumer discretionary. However, weak growth tends to favor defensive sectors, including healthcare and consumer staples. 

Social Factors

Shifting social and cultural trends significantly impact sector prospects. Demographic changes, wealth distribution, educational attainment, and attitudes drive consumer demand patterns. Generational differences also affect preferences. Population growth rates by age segments determine future labor force capacity. Understanding societal changes allows for determining which sectors align best with emerging structural shifts.

Technological Factors 

The pace of technological change and innovation is rapidly transforming industries. Sectors on the leading edge of technology, like software, semiconductors, and internet services, tend to see stronger growth. At the same time, sectors disrupted by technology face competitive threats. Adoption rates of new technologies like artificial intelligence, process automation, autonomous vehicles, renewable energy, and biotech influence sector winners and losers. Tracking technological catalysts and risks is a key driver of equity sector performance.

Legal Factors

The legal and regulatory environment creates operating constraints and risks for companies across sectors. Analysts evaluate new legislation, existing laws, and pending legal issues relevant to each sector. Stringent regulations, penalties for non-compliance, and litigation risks negatively impact impacted sectors. In contrast, relaxed oversight and business-friendly legal reforms favor certain industries. The legal landscape determines the competitive leeway and costs for players in a sector.

Environmental Factors 

With rising ecological awareness and climate change risks, environmental factors significantly sway sector prospects. Stricter regulations on emissions, natural resource usage, and sustainability practices raise costs for heavy polluters. Sectors like fossil fuels and manufacturing face headwinds. Meanwhile, sectors supporting energy efficiency, renewables, recycling, and organic products benefit from the “green” trend. The environmental analysis informs sector positioning strategies.

Size Factors 

A sector’s sheer size and growth trajectory influence its investment potential. Larger sectors make up a greater share of stock indices and the overall economy. Analysts focus on total revenue, market capitalization, and growth rates. Large, rapidly growing sectors like technology see sizable inflows from institutional investors. Stable large-cap sectors also attract significant assets. However, small niche sectors with surging growth outperform despite the smaller size.

Age Factors

A sector’s place within its life cycle affects its outlook and risk-return profile. Rapidly emerging new sectors in the introduction phase, like biotech and internet companies in the 1990s, offer huge upside but also high volatility. Mature sectors like utilities in the stagnant phase tend to underperform with lower volatility. Cyclical sectors rise and fall. Identifying a sector’s lifespan position provides perspective on expected returns.

Focus Factors

The breadth of a sector’s focus impacts the investment landscape. Highly diversified sectors like healthcare span industries from pharma to insurers to hospitals. This diversification reduces risk. Meanwhile, very concentrated niche sectors like precious metals are vulnerable to commodity swings. A wider reach supports stability, while a narrow concentration increases binary risks. 

Substitute Factors

The threat of substitute products or services affects a sector’s durability. Traditional media sectors like print and broadcast have been disrupted by digital substitutes. The auto sector faces substitutes like public transit. Banking faces fintech substitutes. Analysts examine how easily sector offerings are replaced or outdated. High substitutability increases risk. But unique value propositions with no close substitute offer protection.

By analyzing these key factors systematically, investors are able to evaluate sector attractiveness and risks. The top-down perspective complements bottom-up stock analysis for comprehensive equity research. An informed sector view allows tailoring portfolios towards favored macro environments.

How to do sector analysis of a stock?

Sector analysis is done by examining the performance, trends, growth drivers, risks, and outlook of the industry sector that the company belongs to in order to evaluate the stock’s investment potential within the broader sector context. Sector analysis for Bajaj Auto involves examining the two-wheeler industry outlook, competitive landscape, growth drivers, risks, government policies, economic environment, input costs, and company strategy to evaluate its investment potential. The first step is to identify the broad sector that the company belongs to. Bajaj Auto is an automobile manufacturer in India. It operates in the automobile sector, specifically in the two-wheeler and three-wheeler segments. 

Analyze the competitive landscape within the two-wheeler segment. Key players include Hero MotoCorp, Honda, TVS, Royal Enfield, Suzuki, etc. Assess the market share of each player, their product portfolio, segment focus, sales & profitability growth over the years, etc. Bajaj Auto is the 2nd largest two-wheeler company in India, with a market share of ~20%. It has preserved its market share over the years through a strong brand image and wide distribution network.

The government’s policies and regulations also significantly impact the automobile sector’s growth. Analyze the key policies around emission norms, electric vehicles, taxation including GST rates, incentives for new factories, etc. The Indian government has announced favorable policies like the FAME scheme, which promotes the adoption of electric vehicles. Higher rural incomes and infrastructure spending are also conducive to sector growth. However, higher GST rates on automobiles have negatively impacted demand in the past.

How to know if a particular sector is doing well?

Reviewing industry research, benchmarking performance, examining historical trends, analyzing future demand drivers, and considering qualitative sentiment are used to identify sectors with strong growth prospects across analytic dimensions. Selecting stocks in industries that are expanding provides greater potential for returns compared to stagnant or declining sectors.

Take advantage of already-published industry research from reliable sources rather than beginning from scratch. Organizations like consulting firms, investment banks, and industry associations frequently publish detailed reports analyzing market trends, opportunities, risks, and forecasts. 

Where to find sector analysis reports?

Sector analysis reports are obtained from research houses like CRISIL, brokerage reports, industry bodies like IBEF, and financial news platforms like Bloomberg Quint. 

CRISIL is India’s leading rating agency and is known for its unbiased research. It publishes insightful sectoral analysis reports covering major industries, including automobiles, banking, infrastructure, IT, pharmaceuticals, textiles, etc. These reports analyze growth trends, government policies, demand-supply dynamics, competitive landscape, industry forecasts, and investment outlook. As these reports objectively assess opportunities and challenges for players in a sector, they help investors make informed stock-picking decisions. For example, an investor looking to invest in banking stocks, which refers to CRISIL’s Banking Sector in India report, to understand key drivers, challenges, and performance metrics of major banks before deciding which bank stocks to buy.

Equity research teams of leading stock brokerages also regularly publish sector analysis reports for their client investors. These provide a detailed view of market leaders, growth expectations, financial ratios, risks, and potential triggers for a sector. Brokerage reports sometimes also give stock recommendations, which investors refer to while building their portfolio. For instance, a brokerage’s Pharma Sector Update report could provide insights on regulatory changes, pricing pressures, USFDA actions, new drug launches, and research progress of major Indian pharma companies. Comparing these details across companies guides investors to pick the better-performing stocks.

Industry associations like IBEF, CII, ASSOCHAM, etc, also publish insightful sector reports. For example, IBEF’s automotive industry report provides macroeconomic trends, policy support, growth drivers, segment-wise outlook, major players’ profiles, and developments. As IBEF partners with the government to promote investment in India, its sector analysis provides an independent overview of opportunities. It does not recommend specific stocks, so investors need to assess company-specific aspects before deciding on investments. 

For continual updates across sectors, platforms like Bloomberg Quint (BQ Prime) offer a wealth of data, news, and analysis to guide stock investing. Their sector-specific tracker provides real-time updates, news developments, corporate results analysis, and expert opinion on sectoral trends. Alongside such sector analysis, BQ Prime also provides stock screening tools, price charts, financial data, and valuation models to enable smart stock picking.

What are the tools for doing sector-wise stock analysis?

Major brokerage research reports and financial websites provide an overview of sectors and recommend top stocks. However, for on-the-go analysis, Strike is very useful. Strike is a powerful stock analysis tool that allows users to filter stocks by sector, track rankings, and monitor price movements. Analysts find Strike convenient as it helps dig deeper into sectors on the go and make well-informed investment decisions by comparing stocks across sectors.

What are the different types of sectors in the stock market?

The major sectors of the Indian stock market that investors have an opportunity to invest in are agriculture, aviation, automobiles, banking and financial services, electricals and electronics, FMCG, gas and petroleum, information technology, infrastructure, pharmaceuticals, real estate, telecommunications, textiles, and tourism. 

The agriculture and commodities sector is a major contributor to India’s GDP. This sector includes companies involved in the production, processing, and distribution of agricultural products like grains, spices, sugar, tea, coffee, rubber, etc. Major companies in this sector include ITC, Hindustan Unilever, Britannia, Tata Consumer Products, Godrej Consumer Products, Dabur India, etc. The growth and performance of companies in this sector depend on monsoon, government policy, demand-supply dynamics, etc.

The aviation sector in India has seen tremendous growth in the last decade, driven by rising incomes and a growing appetite for air travel. This sector includes airline companies like Indigo and Spicejet as well as airport operators like GMR Infra and Cochin International Airport. The financial performance of aviation companies is sensitive to aviation turbine fuel (ATF) prices as well as passenger traffic growth. Disruptions like COVID-19 severely impact this sector.

The automobile sector includes two-wheelers, three-wheelers, passenger vehicles, commercial vehicles, and auto ancillary companies. Major players in this sector include Maruti Suzuki, Tata Motors, Mahindra & Mahindra, Bajaj Auto, Hero Motocorp, etc. Demand for automobiles is dependent on economic growth, interest rates, fuel prices, etc. Government policies like vehicle emission norms also impact this sector.

The banking and financial services sector is critical to India’s economy. It includes public and private sector banks like SBI, HDFC Bank, ICICI Bank, Axis Bank, etc., as well as non-banking financial companies like Bajaj Finance, HDFC, etc. The performance of this sector depends on asset quality, credit growth, interest rates, and economic growth. The RBI’s monetary policy and regulations impact this sector.

The electrical and electronics sector includes companies manufacturing consumer electronics, white goods, cables, switches, etc. Major companies in this sector include Havells, Crompton Greaves, Voltas, Dixon Technologies, Amber Enterprises, etc. Demand growth for products in this sector depends on rising disposable incomes and the availability of electricity. Government schemes like rural electrification are positive for this sector.

The fast-moving consumer goods (FMCG) sector manufactures packaged food, beverages, personal care, home care, and hygiene products. Major companies include Hindustan Unilever, ITC, Dabur, Britannia, Godrej Consumer Products, Marico, etc. The rural segment accounts for significant demand for FMCG products. This sector’s prospects are linked to population growth, urbanization, and a rise in per capita incomes.

The gas and petroleum sector involves the exploration, production, refining, and marketing of crude oil, natural gas, and petroleum products. Major listed companies are ONGC, IOCL, HPCL, BPCL, GAIL, Reliance Industries etc. The profitability of companies in this sector depends on global crude oil prices, refining margins, and government regulation on the pricing of fuels.

Which sector is in demand in India?

The information technology sector continues to see strong demand and growth in India, with IT stocks consistently outperforming the broader market. Healthcare and pharmaceuticals is another sector that has seen increased investment and focus, as India aims to improve access to quality healthcare and become a global hub for generic drug manufacturing.

Consumer stocks in areas like retail, banking, and auto have upside potential, given India’s large and growing middle class. The renewable energy sector is also attracting attention and investments as India looks to meet its ambitious targets for solar and wind power generation capacity. 

What are the differences between sector and industry analysis?

Sector analysis examines broad categories of the economy, like technology or healthcare, while industry analysis looks at more specific groups within those sectors, such as software companies or biotech firms. Sector analysis studies stocks at a macro level and provides a broad overview of the opportunities and risks prevalent in a business sector.

For example, analyzing the banking sector covers trends affecting banks, NBFCs, insurance companies, lending institutions, etc. Industry analysis, on the other hand, evaluates stocks at a more micro level, focusing deeply on dynamics influencing a specific industry within that sector. For instance, public sector bank industry analysis covers only PSU bank stocks. Sector analysis encompasses stocks across diverse industries that are interlinked under a broad sector.

For example, energy sector analysis spans the oil & gas, power, renewable energy, and coal industries. Industry analysis only covers stocks of companies engaged in that particular industry. For instance, analysis of the two-wheeler industry only focuses on two-wheeler manufacturers.

How does sector analysis impact fundamental analysis?

Sector analysis looks at the performance and prospects of entire industries, while fundamental analysis evaluates individual stocks. By understanding industry trends and dynamics, sector analysis provides a useful context for interpreting companies’ financial data. For example, knowing an industry is in decline changes the interpretation of a company’s dropping sales.

Similarly, an industry growing rapidly makes a stock seem attractive despite weaknesses in its fundamentals. Incorporating sector analysis alongside traditional fundamental metrics gives a more complete picture of forces impacting a stock’s value and performance.

Arjun Remesh

Head of Content

Arjun is a seasoned stock market content expert with over 7 years of experience in stock market, technical & fundamental analysis. Since 2020, he has been a key contributor to Strike platform. Arjun is an active stock market investor with his in-depth stock market analysis knowledge. Arjun is also an certified stock market researcher from Indiacharts, mentored by Rohit Srivastava.

Shivam Gaba

Reviewer of Content

Shivam is a stock market content expert with CFTe certification. He is been trading from last 8 years in indian stock market. He has a vast knowledge in technical analysis, financial market education, product management, risk assessment, derivatives trading & market Research. He won Zerodha 60-Day Challenge thrice in a row. He is being mentored by Rohit Srivastava, Indiacharts.