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Which category of stocks interests you? - Views on News from Equitymaster
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  • Dec 1, 2009

    Which category of stocks interests you?

    Every field of profession has its share of jargons. Equity market analysis is no different. There is an excessive use of financial lingo which novice investors find difficult to swallow. At times they are even confused about the genre of the company they are interested in. So which type of stock you own? Are you interested in 'growth' or 'value'? Is the one that you already have 'defensive' or 'cyclical'? Confused?

    This article attempts to throw some light on the nomenclature that different analysts use for categorising different stocks.

    At a very basic level, the stocks can be classified as follows:

    1. Quality growth stocks: These usually include established large-cap and mid-cap companies which have are growing at a respectable and steady pace. We are talking about companies having a growth rate of say 15% or so. These companies usually reinvest their profits to expand their business. They do not pay much dividend. But investing in them for long-term is beneficial as price of such stocks usually rise as the companies grow.

      This category can include IT majors like TCS, Infosys and Wipro or automobile giants like Tata Motors or Maruti etc. These large, consistently profitable companies are also known as blue chips (they take their name after the most valuable poker chips.) It is worth noting that these growth stocks are often more expensive than stock in lesser-known or smaller companies.

    2. Emerging growth stocks: This genre usually includes small emerging companies which gain a lot of investor interest through their niche value propositions. These include companies which have crossed their initial stage. Many promising mid and small-cap stocks in the expansion phase and witnessing super normal growth rates fall under this category.

    3. Value stocks: Value stocks primarily stand for companies which are asset-rich. The main attraction for buying these companies is the assets on their balance sheet and not their current earnings. This category usually includes companies from oil & gas, real estate and utilities companies. There is also a different line of thought about value stocks. Stocks that are underpriced (less expensive) are also referred to as value stocks. Reasons for low price can be temporary financial stress on the company or underestimation of the growth potential.

    4. Defensive stocks: Defensive stocks are the ones that are usually recession resistant. Industries which are basic to human needs or vices fall in this category. This includes sectors like electric and gas utilities, drugs, health care, food and FMCG. Demand for their products remains stable even in uncertain economic times. However, they might not have excellent growth rates.

    5. Cyclical Stocks: Cyclical stocks are the ones which may find favour in good times and suffer during bad times. As the name suggests, their revenues and profits are tied strongly to the economy and price fluctuates with the business cycle. This category includes stocks from sectors like automobile, airlines, chemical, railroads etc. Airlines, for example, tend to lose money during recession when people spend less on business and pleasure travel. It is wise to buy cyclicals during recession and sell them on recovery.

    6. Income Stocks: These are the stocks which consistently pay higher than average dividends. Investors (especially old and retired) find these attractive because of the cash-flow they generate. However, one must be cautious while buying such stocks as high dividend can be because of lack of future expansion plans. It is advisable to invest in quality growth stocks having trend of rising dividends.

    7. Penny Stocks: Penny stocks are the ones which are of lower denomination in terms of stock price. They are often mistaken to be 'cheaper' than higher priced stocks, which may not be the case. Also, they are more risky to invest in. While some penny stocks may rise decently in value, many of the companies never see profits. One may seldom find sufficient information to evaluate them properly.

    One cannot draw a clear line between the categories as overlaps are bound to occur. Some 'high -growth' stocks can be 'income' as well. Similarly some 'value' stocks can be 'defensive' and some 'penny' can be 'value' as well. However, we hope this broad categorization will assist investors in knowing which kind of stock they own or are interested in. It can help them make a more informed decision about buying, selling or holding the stock.



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