Most of you must have invested in stock markets. But have you ever wondered about the kinds of stocks that are available in the stock market. Classifying a universe of over 5000 actively traded stocks is no mean task, but there are some broad signals that we can pick up. This classification is important as it enables you to pigeonhole specific stocks to your specific requirements. Here are 6 such categories of stocks that are available in the stock markets…
- Defensive Stocks
As the name suggests, these defensive stocks are known to give steady returns even when the markets are going nowhere. The typical defensive stocks are less vulnerable to business cycles and while they may see some impact on demand and earnings, they are unlikely to be overly impacted by the vagaries of the economic cycles. Defensive stocks are normally not outperformers in the market but your downside risk is also limited. Stocks like Colgate, Britannia and Hindustan Unilever are classic examples of defensive stocks as they are in an industry that is not too cyclical in nature. Sectors like pharma and IT were also classified as defensive stocks in the past but over the last couple of years they have been relatively more volatile due to their over dependence on the US markets.
- Blue Chip Stocks
Blue chips, as the name suggests are the stocks that have a pedigree and a performance track record built over a fairly long period of time. Normally, you find blue chips across sectors and these are companies that show fairly high levels of growth and margin performance. For example, within the auto space, companies like Maruti, Tata Motors, M&M, Bajaj Auto and HMCL will classify as blue chip stocks. Similarly, in the oil sector, stocks like Reliance Industries, ONGC, IOC and BPCL will classify as blue chips. Of course, the list can go on!
- Cyclical Stocks
Cyclical stocks normally perform in tune with the global or domestic cycles. In terms of stock market performance, these cyclicals tend to outperform in the upward phase of the cycle but grossly underperform in the downward phase of the cycle. For example, stocks like L&T and BHEL are largely dependent on the capital cycle in the economy and therefore will outperform when the capital investment cycle in on an upturn. That explains why L&T underperformed between 2012 and 2016. Similarly, stocks like Tata Steel and Hindalco are heavily dependent on the global demand and price cycle of steel and aluminium respectively. That explains why these two stocks have done so well in the last 1 year when Chinese demand has been on an upturn and prices on the LME are moving up.
- Dividend Yield Stocks
These stocks are also popularly known as Income Stocks. These are stocks where the dividend yield (Dividend per share / Market Price) is attractive. Normally, a dividend yield of above 6% makes the stock an attractive proposition as dividends are tax-free and hence the post-tax yield is much higher. The attractive dividend yield acts as a kind of a price support for the stock, which limits its downside risk. Investors who want steady income can look at these stocks. However dividend yield stocks are not known to outperform in price terms.
- Growth Stocks
Growth stocks are those that are showing high visibility in terms of growth in sales, earnings and in the operating margins. It is this combination that actually makes a growth stock. Normally, growth stocks tend to give tremendous stock market outperformance during the growth phase. Bharti Airtel between 2002 and 2007 is a case in point. Similarly, Eicher Motors has delivered stellar growth in top-line, profits and margins consistently for the last 32 quarters. That is perhaps the reason why the stock has moved up from Rs.200/ share in 2009 to Rs.30,000/- per share in 2017. Normally, growth stocks tend to quote at rich and expensive P/E ratios in the market. However, such growth stocks should be judged based on their PEG ratio and not purely on their P/E ratio.
- Value Stocks
Many times the concept of value stocks can be a misnomer. Value stocks are those that are available at very cheap valuations. The only problem in this approach is that low P/E or low P/BV does not necessarily guarantee stock market returns. This value stocks approach holds out when the market overall is at all-time low valuations. For example, in the market of 2002 or in the lows of 2009, most of the frontline stocks were available at bargain valuations. Under these circumstances, the value approach works to perfection. However, whenever one takes the value stocks approach to buying, one must be very careful of the P/E trap. In many cases, low P/E is indicative of larger structural problems in the industry or in the company. You must be wary of that.
Many of the above classifications are likely to overlap. For example, a blue chip stock may also be a growth stock or a cyclical stock may also be a value stock. The idea is to create your investment target and pick stocks accordingly.