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I've read a lot about the importance of sector analysis and industry analysis. Just when I think I have a grasp on which is which, I end up back at square one. Can you let me in on what distinguishes the two, an industry and a sector? -- M.S.

In the investing world, the grouping of stocks into industries and sectors is one of the most popular ways of categorizing them. The idea is this: It's a lot easier to compare the performance of two companies in the same field, which perform similar business functions, than to compare the performance of two unrelated companies. These fields -- which are known to investors as industries or sectors -- are essentially just classifications that can help us isolate stocks that are of specific interest.

Which Is Which?

So what exactly makes the two classifications different? Not as much as you might think. These days, they're reasonably analogous. The purists will tell you that the difference between an industry and a sector basically boils down to scope. Generally, a sector is considered to be the broader of the two. Sectors slice the economy into big chunks -- each of which is home to multiple industries.

Here's the kicker, though: The two terms are sometimes reversed. Fundamentally, the best way to keep things straight is by looking at the context in which the word is used. If the word "industry" or "sector" is being used by itself, then it's generally safe to take either word to mean the same thing.

Industry Breakdowns

As if the lack of a strict definition weren't enough, the way the industries and sectors themselves are defined in the real world could fall within any of a number of industry classification schemes. That said, measures do exist for what constitutes an industry or sector.

Financial companies are fond of using systems of industry classification that are somewhat different from those used in "administration" (our friends at the Securities and Exchange Commission and Internal Revenue Service). Two of the principal players in the industry/sector classification game are the Global Industry Classification Standard and the Industry Classification Benchmark.

The GICS was developed by Standard & Poor's and Morgan Stanley, while the ICB was the work of Dow Jones and the FTSE Group. While both systems are effective and very similar in the way they classify companies, it is worth noting that the ICB system defines an industry more broadly than it does a sector.

From a federal administrative point of view, the end-all, be-all system for industry classification is the aptly named North American Industry Classification System. They're the ones responsible for those industry codes that you'll see on a company's 10-K (the SEC still uses the codes from its predecessor) or tax return.

The NAICS is maintained by the U.S. Census Bureau, which reviews its list of included industries every five years. Its classifications run the gamut, from the broader sector-like classifications (such as agriculture) to notably specific industrial classifications (such as dry pea and bean farming).

Hierarchies for each of these systems can be found online at:

Industry Behavior

Regardless of the system you or your financial institution use, the important thing is that the classifications are used appropriately as the tools they were designed to be. Looking at stocks from an individual level does have its limitations, and that is why industries and sectors are so valuable.

When analyzing a stock, looking at it from an industry -- or even sector -- level can give you a wealth of reference in your analysis. Is the stock beating its industry? Is it beating its sector? While you may think that a retailer's profit margins are impressive compared with those of, say, an airline, unless you make those comparisons with the sector or industry the stock is in, you won't be getting as much relevant information from your comparison.

If you have an interest in a particular industry, familiarize yourself with it. Each industry and sector has its own jargon, its own ratios and its own measures of performance. If you learn more about any industry as a collective, you'll be putting yourself in a position to better capitalize on readily available information.

Industry Investing

If you are interested in investing in an industry -- or in several -- there are a number of things you might want to think about.

Diversify!: From the day you became interested in investing, you probably heard that a million times. Which is why it's important to remember that investing in a given industry isn't diversification; it's concentration. Although investing in an entire industry can hedge, or protect against, some of the risk involved in individual stocks, it won't protect you if the bottom falls out of the industry you're investing in.

One way to lessen the degree you're exposed to market conditions (such as the recent plight of the airline industry) is by engaging in sector rotation. Sector rotation is basically the act of moving your holdings from one industry to another to avoid a cyclical slump in your portfolio. As always, the old rule of diversification stands strong: There's no reason why you can't diversify your portfolio by investing among several industries or sectors.

There was a time when investing in an industry was not as simple as buying an individual stock, but with the options available to investors today, that's really not the case anymore. In addition to investing in individual stocks, investing in an index fund or industry-mirroring exchange-traded fund (or ETF -- check StreetSmarts: What's an ETF? ) is a great way to instantly buy a stake across an industry.

Investing in individual stocks within an industry offers the greatest amount of flexibility, as well as the greatest amount of work. This is not recommended for most novice investors or for investors who are short on time. Cherry-picking stocks won't necessarily result in any better results than investing in an index portfolio. Industry index funds, on the other hand, provide a means for investing in an entire industry or sector in one fell swoop.

The area of industry/sector investing is deep -- there's no doubt about that. Many a career has been born on the ability to make accurate judgments about sector and industry performance. The difference between an industry and a sector may be a bit subtle, but the effect they can have on your portfolio is nothing to sneer at.

For more on the basics of ETFs, mutual funds, and other investing fundamentals, check out TheStreet.com University's Getting Started Section.
Jonas Elmerraji is the founder and publisher of Growfolio.com, an online business magazine for young investors.

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