Using GICS Sectors for Dividend Stocks - The Dividend Experiment

On why dividend investors should ignore traditional GICS sectors for dividend stocks and focus instead on finding true Natural Dividend Payers.

If you’ve done research on stocks you’re interested in buying, you may have come across the GICS sectors, Global Industry Classification Standard, before.

However, using these GICS Sectors for dividend stocks is not ideal and I will explain why below.

GICS is a system developed by MSCI, Morgan Stanley Capital International, and S&P Dow Jones Indices to classify companies into different industry sectors and sub-industries.

The GICS consists of 11 sectors, each divided into various industry groups, industries, and sub-industries.

The GICS Sectors

The GICS sectors are as follows:

Energy: Companies involved in the exploration, production, and distribution of energy, including oil, gas, and renewable energy sources.
Materials: Companies engaged in the extraction, processing, and production of raw materials such as metals, chemicals, and forestry products.
Industrials: Companies involved in the production of goods and services, including manufacturing, aerospace, defence, and transportation.
Consumer Discretionary: Businesses related to non-essential goods and services such as retail, automotive, travel, and entertainment.
Consumer Staples: Companies that produce and distribute essential products, including food, beverages, household goods, and personal care items.
Healthcare: Businesses in the healthcare industry, including pharmaceuticals, biotechnology, medical equipment, and healthcare services.
Financials: Companies in the financial sector, including banks, insurance companies, real estate, and other financial services.
Information Technology: Businesses involved in technology, software, hardware, and services related to information and communication.
Communication Services: Companies providing communication and media services, including telecommunications, entertainment, and media content.
Utilities: Companies that provide essential services such as electricity, water, and gas.
Real Estate: Businesses involved in the ownership, development, and management of real estate properties, including REITs, or real estate investment trusts.

Each sector is designed to encompass companies with similar business activities.

This classification system is widely used by the global financial community for investment research, portfolio management, and benchmarking.

It helps investors and analysts compare companies within the same industry to make more informed investment decisions.

The GICS sectors Problem: The Communication Sector

Here’s the problem: these sectors, particularly the Communication Sector, kind of suck for finding natural dividend payers that investors like us want for our income portfolios.

In other words, using GICS Sectors for dividend stocks is a bad idea

Let me demonstrate with an example.

One of the worst offenders here is the so-called “Communication Services Sector.”

Now, in the Communication Services Sector, the following three stocks are all included:

AT&T: This company helps to facilitate communication through its infrastructure and network.
Meta, or what was originally called Facebook: this one is mainly a social network where people communicate, so it has some function of communication with it. I guess it makes some sense.
Netflix: Media is communication. But it feels like a bit of a stretch.

Now, the problem is: how do we compare AT&T’s financial and business model to Netflix or Facebook?

They’re completely different. Let’s look at a snapshot of each.

Comparing AT&T, Meta, and Netflix as Dividend Options

AT&T

First, we have AT&T. We can look at a few of the metrics here that will already show how different it is.

Dividend yield is relatively high; it’s 6.61%, which is much higher than the market average.
The P/E ratio is 8.02. The P/E ratio is the relationship between the company’s stock price and the earnings per share. So, the lower the P/E ratio, the less you’re paying for $1 of profit per share. With that in mind, a lower P/E ratio means the stock is potentially cheaper.
Finally, the last metric is the beta. This is how volatile the stock is compared to the market as a whole. In this case, AT&T is pretty low.

Netflix

Netflix doesn’t pay a dividend, and it’s likely not at that level of company development yet, so there’s no spare money to be paid out. Obviously, a very different situation from AT&T.
Its PE ratio is the highest of the three at 49.6, and this means that people are expecting the company to grow further, as they’re paying $49.60 for each dollar of current profit.
Finally, the beta is 1.22, so again, another company that’s more volatile than the market.

So, can you really say these stocks are in the same sector? Are they comparable? Not really.

This is obviously a big problem for dividend investors trying to diversify an income portfolio.

However, I have a solution: a new sector classification that is much better for dividend investors.

A Better Solution than GICS Sectors for Dividend Stocks

These are some adjusted categories for dividend investors that help decide which sectors you’re more likely to find what I call Natural Dividend Payers.

These are essentially the type of companies that should be paying dividends, and there are many companies that definitely shouldn’t.

Essentially, a company that has

A predictable flow of income, things like subscriptions
A significant level of profit
Hit a mature level of the company’s development
Produces and sells something in demand, things like needs rather than wants
A sustainable client or customer base,
A strong moat.

To give a more tangible example: National Grid, the energy infrastructure company, fits the natural dividend payer archetype very well.

It’s at a mature level of development, its moat is protected by government licenses, and it provides a need, etc.

Looking at National Grid, we can see that it does pay a sizable dividend and has a lengthy history of paying it, as it’s at the natural dividend payer stage of its development as a business.

New Categories for Finding Natural Dividend Payers

If we’re looking for natural dividend payers, we don’t want to use GICS Sectors for dividend stocks – we want to organise the sectors into easier-to-interpret categories, and then we can focus on categories that tend towards being natural dividend payers.

So I made these categories instead:

Energy and Commodities
Banks and Financials
Utilities and Infrastructure
Real Estate
Consumer Necessity
Components and Production
Pharmaceuticals and Medical Research
Innovative Tech
Consumer Luxury

Some of these are more inclined to have natural dividend payers than others, and I’ll go through the ones most likely to find natural dividend payers.

Categories Most Likely to Find Natural Dividend Payers

Utilities and Infrastructure

Companies here have to be pretty tragically bad to lose their license, which keeps their business in place.

They’re also permitted in an amount of profit per year that can be dispersed to shareholders.

These companies often have large capital expenditures, so they aren’t going to be insanely profitable, but they are often very reliable as dividend-paying companies.

I mix utilities and infrastructure together, and I would include telecommunications in here, as it’s essentially infrastructure at this point in our society.

Banks and Financials

Companies in this sector are pretty good dividend payers.

They deal with capital and moving capital around, so paying out dividends is relatively simple.

They do tend to get picked on during tough times in the economy, and governments may force them to pause dividends.

But otherwise, they tend to be pretty reliable payers.

I would put banks, obviously, then insurance-type companies, and also business development companies in this section.

Basically, anything that has to do with managing money goes in here.

Real Estate

REITs, or real estate investment trusts, are pretty good natural dividend payers.

They get regular payments of rent and are mandated to pay out a huge chunk of profits to shareholders as part of their business structure.

Anything to do with real estate goes in this section, and it’s similar to the original category.

Consumer Necessity

This is one that’s a slightly bigger shakeup.

The meaning of necessity here is more in the style of the economic concept of a necessity, i.e., something that has a price elasticity of demand under one.

This may mean that some things we wouldn’t usually describe as being necessary, like tobacco or alcohol, actually come under this category, as people still tend to spend on them even if the prices go up or if their incomes go down.

Components and Production

Think about industrials in the previous categorisation, but include some other companies that are more production-focused.

So, what would be considered tech companies, but in fact are more hardware-focused, can go in this category.

Medical device companies also go in here, as making a hospital bed or equipment is different from biopharmaceutical research.

Like industrials, this is a pretty good sector to find natural dividend payers.

Energy and Commodities

This pairing makes less sense in the general stock market, but a lot of sense for us.

Energy is essentially a commodity, as we’ve reduced it to just oil, gas, and coal, now that utilities and infrastructure have taken all the pipelines, etc., out of it.

And they’re all pretty cyclical as industries, so you’ll most likely want to go with the bigger supermajors if you want reliable dividend income from the energy and commodity sector.

And then there are some categories where I think it would be very unlikely to find natural dividend payers, to the point where I’d probably avoid these categories as a starting point to look when building a dividend portfolio.

Categories to Avoid When Starting a Dividend Search

Pharmaceuticals and Medical Research

Pharmaceuticals, especially in the early stage, don’t really have much business paying dividends.

They should be using their capital to focus on research and development, as that is likely to have a much higher return on capital invested than paying out to us shareholders, assuming that they are successful, which you’d have to assume they are, or why invest in them in the first place?

There is an argument that once a pharmaceutical company grows large enough, as in, so-called big pharma, it should be moved to consumer necessity.

Think of companies like Novo Nordisk, Pfizer, or AbbVie, where they supply widely used medicines that more closely fit the description of a consumer necessity.

Innovative Technology

Like biopharmaceuticals, companies in the innovative tech sector are most likely going to get better returns for shareholders by just doing their thing rather than paying out dividends.

So let them do their thing.

On top of that, a lot of these companies are burning through venture capital funds, so they aren’t profitable enough to be paying dividends anyway.

Once they’re big enough to be making substantial profits, they’re probably going to move into either consumer luxury, like Apple, or they can move into components and production, like Cisco or Seagate.

Consumer Luxury

Where consumer necessities are things that people are willing to continue to buy even if the price goes up or their income comes down, consumer luxury is the opposite of that.

These are things that people ditch as soon as the going gets tough or generally buy less of.

And these aren’t usually great dividend payers, as their fate is linked heavily to the economy.

When the economy is going well, then they might pay out dividends, but then sharply cut when the economy is not going so well.

Fashion also goes in here, as people can turn on a dime; something that’s popular now may well be very unpopular at any moment.

I would also put automobiles in this section, and I think they often have high yields that seem attractive but can be very unreliable stocks.

So those are the categories I have so far. But this solution is not perfect yet. I’ve already thought of a few types of stocks that don’t really fit in.

Categories of Stocks that don’t fit in

Shipping companies

Can’t really cast them as components in production, and I’d argue they’re not very good dividend payers due to the super-cyclical nature of their companies, so I wouldn’t want them to go in that category anyway.

Do they need a new category? But if so, what else would go with it?

Companies that provide services with personnel

So companies like G4S or Page Recruitment.

They would have gone in the old C of industrials as their industry adjacent, but they aren’t really components in production and don’t really fit with others in that category that I made.

Internet-based stocks that aren’t exactly innovative tech

Like Rightmove and MoneySuperMarket.

Do we lump them in with innovative tech anyway? Which seems a shame, as MoneySuperMarket does appear to be quite a reliable payer; its recent history has been decent.

Ultimately, the issue isn’t that GICS is broken; it’s that it wasn’t built for income investing.

Grouping totally different businesses like AT&T, Meta, and Netflix together shows how misleading GICS Sectors for dividend stocks can be when you care about cash flow and payout reliability.

By instead focusing on categories that reflect how companies actually earn and distribute money, like Utilities and Infrastructure, Banks and Financials, Real Estate, Consumer Necessity, and Components and Production, you naturally gravitate toward true Natural Dividend Payers.

In other words, don’t let index labels drive your income strategy; let the underlying business model and its stage of maturity do the talking.