Show pageOld revisionsBacklinksBack to top This page is read only. You can view the source, but not change it. Ask your administrator if you think this is wrong. ====== Standard Industrial Classification (SIC) system ====== ===== The 30-Second Summary ===== * **The Bottom Line:** **The SIC system is the economy's old-school filing cabinet; a numerical system that groups companies into specific industries, allowing you, the investor, to quickly understand a business and compare it to its true rivals.** * **Key Takeaways:** * **What it is:** A four-digit coding system developed by the U.S. government to classify businesses by their primary type of activity. Think of it as the Dewey Decimal System for companies. * **Why it matters:** It's the essential first step for [[relative_valuation]]. To know if a company is cheap or expensive, you must compare it to its peers, and the SIC code is your primary tool for identifying that peer group. * **How to use it:** Find a company's SIC code in its [[sec_filings]], then use that code in a stock screener to generate a list of competitors for a powerful side-by-side analysis of their financial health and valuation. ===== What is the Standard Industrial Classification (SIC) system? A Plain English Definition ===== Imagine walking into a massive library where every book represents a publicly traded company. Without a cataloging system, finding what you want would be impossible. You'd find a history book next to a cookbook, a sci-fi novel next to a car repair manual. It would be chaos. The Standard Industrial Classification (SIC) system is that library's catalog. Developed in the 1930s, it's a simple yet powerful system designed to bring order to the chaos of the business world. It assigns every company a four-digit code based on its primary business activity. This code acts like a company's address within the economy, telling you exactly which neighborhood it lives in. The four-digit code is hierarchical: * **First two digits:** Identify the //Major Group//. For example, codes `20-39` cover Manufacturing. * **Third digit:** Narrows it down to an //Industry Group//. For example, `283` is Drugs. * **Fourth digit:** Pinpoints the //Specific Industry//. For example, `2834` is for Pharmaceutical Preparations. So, if you see a company with SIC code 2834, you instantly know it's in the business of making pharmaceutical drugs, like Pfizer or Merck. You know it's not an airline (`4512`), a steel mill (`3312`), or a restaurant (`5812`). While a newer system called the [[north_american_industry_classification_system_naics|North American Industry Classification System (NAICS)]] was introduced in 1997 to provide more detail and cover modern industries, the SIC system remains incredibly widespread. You'll find it in virtually every company's annual report (10-K) and it's still a core feature of most financial data services and stock screeners. For an investor, it remains an indispensable, time-tested tool for the initial phase of any analysis. > //"Know what you own, and know why you own it." - Peter Lynch// ===== Why It Matters to a Value Investor ===== For a value investor, the SIC system isn't just an administrative detail; it's a foundational tool for applying core investment principles. It directly supports the three pillars of intelligent investing: understanding the business, performing disciplined valuation, and maintaining a [[margin_of_safety]]. 1. **The Foundation of Your [[circle_of_competence]]:** Warren Buffett's most famous rule is to never invest in a business you cannot understand. The SIC code is the first checkpoint on that journey. By identifying a company's industry, you can immediately assess if it falls within your circle of competence. If you're an expert in retail (`SIC 5200-5999`) but know nothing about semiconductor manufacturing (`SIC 3674`), the SIC code is your friendly warning sign to either move on or prepare for a very steep learning curve. It enforces intellectual honesty from the very beginning. 2. **The Power of Apples-to-Apples Comparison:** A value investor's central task is to determine a company's [[intrinsic_value]] and compare it to its market price. A huge part of that process involves [[relative_valuation]]—seeing how the company stacks up against its direct competitors. It makes no sense to compare the [[price_to_earnings_ratio]] of a slow-growing utility company to that of a high-growth software startup. The SIC system allows you to pull a list of a company's true peers, creating a "lineup" of similar businesses. You can then compare their valuation multiples, profit margins, debt levels, and growth rates. This context is everything. An "expensive" looking stock might actually be cheap relative to its industry, and a "cheap" stock might be a [[value_trap]] if all its competitors are even cheaper for a good reason. 3. **Separating Industry Tides from Company Leaks:** When a company's stock is performing poorly, is it because the company itself has a problem, or is the entire industry facing a headwind? The SIC system helps you answer this crucial question. By analyzing the performance of an entire SIC group, you can see the "industry tide." If all companies in SIC `1311` (Crude Petroleum and Natural Gas) are down, it's likely due to falling oil prices, not a unique failure at one specific company. Conversely, if one company is thriving while all its SIC peers are struggling, you may have just found a business with a powerful [[economic_moat]]. This insight is critical for understanding risk and identifying truly exceptional businesses. ===== How to Apply It in Practice ===== The SIC system is not a theoretical concept; it's a practical tool you can start using today. Its real power is unlocked when you use it to build a peer group for comparative analysis. === The Method === Here is a simple, four-step process to put SIC codes to work: - **Step 1: Locate the SIC Code.** The easiest place to find a company's SIC code is in its regulatory filings with the Securities and Exchange Commission (SEC). Go to the SEC's [[https://www.sec.gov/edgar/searchedgar/companysearch|EDGAR database]], search for a company, and open its latest 10-K (annual report). The SIC code is typically listed right at the top of the document, identified as "Commission File Number" or near the business address. Many financial websites like Yahoo Finance or Bloomberg also list it on the company's profile page. - **Step 2: Build the Peer Group.** Once you have the four-digit code, use a stock screening tool. Nearly all screeners (including free ones from Yahoo Finance, Finviz, or your brokerage) allow you to filter companies by industry. Simply input the SIC code (or the corresponding industry name) to generate a list of all publicly traded companies operating in that same specific business. - **Step 3: Compare Key Metrics.** Now you have your apples-to-apples lineup. Create a table and compare your target company to its peers across the metrics that matter most for that industry. This could include: * **Valuation:** Price/Earnings, Price/Book, Price/Sales, EV/EBITDA. * **Profitability:** Gross Margin, Operating Margin, Net Margin, Return on Equity ([[roe]]). * **Financial Health:** Debt/Equity Ratio, Current Ratio, Interest Coverage. * **Growth:** Revenue Growth (3-5 years), Earnings Growth (3-5 years). - **Step 4: Ask the "Why?" Question.** This is the most important step. The data doesn't give you the answer; it helps you ask the right questions. Why is your target company's P/E ratio half that of the industry average? Does it have lower growth prospects, or is the market overlooking its strengths? Why are its profit margins twice as high as its closest competitor? Does it have a superior brand, a patent, or a cost advantage—in other words, an economic moat? The comparison illuminates the anomalies, and investigating those anomalies is where true investment insight is born. === Interpreting the Result === An SIC code itself doesn't have a "good" or "bad" value. Its utility comes entirely from the context it provides. When you analyze the peer group you've assembled, you are looking for outliers. * **A Significantly Cheaper Outlier:** If a company trades at a much lower valuation than its SIC peers, it could be a potential value opportunity. The market may be overly pessimistic about a temporary problem. Your job is to investigate if the discount is justified or if you've found a classic "dollar bill for fifty cents." * **A Significantly More Profitable Outlier:** If a company consistently posts higher margins or returns on capital than its SIC peers, it's a strong indicator of a competitive advantage. This is the starting point for a deep dive into its business model to understand the source and durability of that advantage. * **A Company in the Middle of the Pack:** A business that looks average on all metrics compared to its peers isn't necessarily a bad investment, but it's unlikely to be an extraordinary one. It suggests the absence of a strong moat and may mean its future returns will likely mirror the industry average. The goal is to use the SIC-generated peer group to anchor your analysis in reality, helping you avoid overpaying for a mediocre business or prematurely dismissing a gem that the market has mispriced. ===== A Practical Example ===== Let's analyze two hypothetical restaurant companies to see the SIC system in action. Both operate in the same broad food service space. * **Company A: Burger Barn Inc. (BB)** is a classic fast-food chain, specializing in burgers and fries. It owns no real estate, instead leasing all its locations. * **Company B: Real Estate Restaurant Group (RERG)** is a company that also operates a chain of diners, but its primary business model is buying the prime real estate for its locations and then franchising the restaurant operations. On a surface level, both might be classified under **SIC 5812: Eating Places**. An investor might be tempted to compare them directly. But a deeper look reveals they are fundamentally different businesses. Let's use the SIC code to build a proper peer group for Burger Barn Inc. We would screen for other companies in SIC 5812 that are primarily "quick-service restaurants." We'd find peers like McDonald's, Wendy's, and Burger King's parent company. Now, let's create a comparison table: ^ Metric ^ Burger Barn (BB) ^ RERG ^ Peer Average (Fast Food) ^ | P/E Ratio | 15x | 30x | 25x | | Debt/Equity | 0.5 | 4.0 | 0.8 | | Business Model | Sells burgers & fries | Owns real estate, collects rent & franchise fees | Sells burgers, chicken, etc. | | Key Asset | Brand, operational efficiency | Prime commercial real estate | Brand, franchise system | **Analysis:** Without the SIC peer group, an investor might look at Burger Barn's P/E of 15x and RERG's of 30x and conclude that Burger Barn is the cheaper, better buy. However, the SIC-driven analysis reveals the truth. Burger Barn's P/E of 15x is dramatically lower than its true fast-food peer average of 25x. This is a massive red flag or a huge opportunity. We must ask: Why is it so cheap? Is there a food safety scandal? Is management incompetent? Or is the market missing something? Conversely, RERG is a completely different animal. Its high Debt/Equity ratio and high P/E ratio are not comparable to Burger Barn. Its true peers aren't other fast-food operators, but perhaps Real Estate Investment Trusts (REITs) or other property-heavy companies. Comparing RERG to McDonald's is a classic apples-to-oranges mistake. This example shows that the SIC code is your starting point, not your final destination. It guides you to the right ballpark so you can start a meaningful game of analysis. ===== Advantages and Limitations ===== Like any tool, the SIC system has its strengths and weaknesses. A wise investor knows both. ==== Strengths ==== * **Standardization and Simplicity:** It's a universal, easy-to-understand system that has been in use for decades. This makes it simple to compare companies across different data platforms and over long historical periods. * **Excellent Starting Point:** It is arguably the fastest and most effective way to begin any investment research process. In seconds, it answers the fundamental question: "What business is this company really in?" * **Widely Available:** You don't need an expensive data subscription. SIC codes are freely available in public documents, making this a powerful tool for the individual investor. ==== Weaknesses & Common Pitfalls ==== * **It's Outdated:** The SIC system was last updated in 1987. This is its single biggest flaw. It has no specific codes for industries that barely existed then. Where do you classify a company like Google? Is it an advertising company (`7311`), a software company (`7372`), or something else entirely? Amazon is classified as a retailer (`5961`), which completely ignores its massive cloud computing business, AWS. This can be highly misleading. * **Oversimplification of Conglomerates:** A complex company like Berkshire Hathaway or General Electric operates in dozens of distinct industries. Assigning it a single SIC code tells you almost nothing about the true nature of its diversified operations. You must analyze these companies segment by segment. * **Company Discretion:** Companies often have some leeway in choosing their primary SIC code. They may choose a code that aligns them with a "hotter" industry to attract a higher valuation. A slow-growing insurance company might try to classify itself as a "fintech" business. Always be skeptical and verify that the code reflects the economic reality of the business. * **NAICS is More Modern:** The [[north_american_industry_classification_system_naics|NAICS]] is a more detailed, relevant, and comprehensive system. While SIC is still more common in many financial databases, savvy investors should be aware of NAICS and use it when available, as it provides a more granular and modern view of the economy. ===== Related Concepts ===== * [[circle_of_competence]] * [[relative_valuation]] * [[industry_analysis]] * [[economic_moat]] * [[sec_filings]] * [[north_american_industry_classification_system_naics]] * [[value_trap]]