Basics of Stock Classification and Investment

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Investors usually classify stocks into groups and sectors according to the type of their business. The idea is to compare one business type with the other for the purpose of investment. Although there are about a dozen sectors, investors mostly group them into two broad sectors: defensive sector and cyclical sector.

Defensive sector

Defensive sector stocks primarily include utilities and consumer staples. Since the supply and demand in consumer goods usually do not undergo any major changes, therefore the prices of the defensive stocks do not follow the overall market trends.

This is because the people do not stop using energy or buying their daily consumption needs. The result is that the companies dealing with consumer staples do not take direct hits immediately, though they may see changes in supply and demand in the long run.

While it is true that the defensive stocks do not suffer losses due to downward trends, it is also true that they do not climb up during bull runs. Since the demand level of the consumers does not rise with the uptrend of the overall stock market, the supply level, therefore, does not rise.

As the name suggests, the defensive stocks provide a kind of cushion during the market crashes.

Cyclical stocks

Nearly all other stocks are covered under the cyclical sector. Some of the stocks in this sector include basic materials, capital goods, communication companies, financial products, health care products, technology and transportation stocks. Cyclical stocks fluctuate with various market factors.

Cyclical stocks are so called because they tend to move up and down according to the business cycles and other influences.

Take the example of lumber which is a raw material for many finished goods, especially in housing construction. As long as the housing market is on the rise, the price of lumber stock too will tend to rise, but when certain factors such as high interests affect the housing market, the demand of lumber also falls and so does the price of a lumber stock .

Stock classification is very useful in helping the investors to compare the stock they have bought, or, intend to buy with other stocks.

You may, for example, want to find out why one stock has an 8% price increase, whereas the other stock has an 11% price increase.

There is yet another way to classify stocks. We can classify them in respect of their growth, value and income potential.

Growth investors, as the name implies, look for stocks that have growth potential. The prices of growth stocks are usually high. Growth investors hunt for rising stars in stock market-companies that are young and show promises of becoming leaders in their industry.

A perfect example of growth stocks was technology stocks in the late nineties. Most of these companies originated with just an idea and rose to become industry leaders. This is not to suggest that every new company has the potential to become prosperous. Some of them fail to live up to expectations.

Value Investors

Value investors look for stocks that have great intrinsic value but are generally overlooked by others. Value stocks do not mean cheap stocks, but the ones that are undervalued in contrast with their true value. These stocks usually have low price / earning ratios. This means that their shares do not command much premium in the market.

Income Investors

Income investors have a simple and straightforward philosophy. They are usually more conservative and are solely interested in income. They therefore try to invest more in companies who have high dividend payout.

Investors who aim at savings for their retirement typically opt for such companies. If their stock prices increase, it comes as an icing on the cake. Wal-Mart is one such company which attracts investors despite the high price of its shares.