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Here's how you classify shares…

Indira Vergis

Surviving the madness that is the stock market usually calls for a calm head and nerves of steel. Time and again, you'll find some stocks roaring past others; while others will send shock waves through the market with their plunging values.

For novices, it can be a treacherous ride: it's important to understand that all stocks do not and will not put in a similar performance. There are different sorts of stocks, and expectations will differ.

Stocks can be sliced and diced in different ways.

For one, they can be classified according to market capitalisation. Market capitalisation is arrived at by multiplying the price of one share by the number of outstanding shares.

So if the price of a company share is Rs 50 and the number of outstanding shares is 1,00,000, then the market capitalisation of that stock is Rs 50,00,000. Greater the number of outstanding shares, the easier it is to trade in that stock.

Conventionally, stocks that boast a market capitalisation of over Rs 5 billion are rated as large capitalisation (large-cap) stocks. At the other end, we also have "penny stocks", which trade at less than Rs 10 per share.

The ones that fall in between these two categories are called medium capitalisation (mid-cap) stocks.

Other experts prefer to rate stocks on their growth potential. Growth stocks are expected to outpace the growth of the broader market, or the benchmark index.

This category usually groups together stocks of companies in new and upcoming industries, those that are exploring new markets and of aggressive upstarts that have successfully managed to chip away at the dominance of an established yet perhaps, complacent market leader.

One good example here is that of companies in the promising new area of business process outsourcing in information technology.

BPO, which involves taking on the back-end data processing and customer query handling jobs of multinationals across the globe at Indian operation centres, is tipped to grow at around 70 per cent in the next few years.

In contrast, the technology sector, as a whole, is expected to grow by about 25 per cent.

There are also many investment managers out there who bow their heads in reverence to value investing: a highly celebrated style of investing first propounded in 1934 by Benjamin Graham in a book co-authored by him called Security Analysis. In recent times, the US-based Templeton fund house has been known for its fondness for value stocks.

In a very broad sense, this style evaluates what an ongoing concern would be worth if it were sold tomorrow. This value is called the intrinsic worth of the business. When the share price falls below intrinsic worth, it's a strong signal that the stock is ripe for a purchase, say value advocates.

Shares of many state-run companies fall into this category. While they may have sturdy financial numbers, the shadow of being government-controlled continues to blight their share valuations.

The reasoning being that since they are state-run, they will be less skilful and swift (compared with a private firm) at reacting to any negative forces in their business environment.

Yet investors continue to flock to these shares in the hope that one day, the companies will be able to cut themselves adrift from government control and unlock the full potential inside them. Examples include Bharat Heavy Electricals and National Aluminium Company.

Stocks may also be classified according to the business the company deals in. That means if a company is in the business of making software, it's labelled an IT stock and if makes cars, it's known as an automobile stock.

Besides, there's a large faithful following of ordinary investors that likes to invest in stocks reputed for rewarding shareholders with regular, hefty dividends.

These investors are usually not completely taken in by the unknown's tempting promise of explosive growth: instead, they prefer to stick to established companies that hold a reputation for being good dividend payers.

One of the best examples of this sort of stock is Hindustan Lever, India's largest consumer goods company. Even while recent quarters have thrown its future growth into some doubt, the enthusiasm for the stock remains arguably undimmed. It still remains one of the most sought after stocks in the Sensex.

Nevertheless, spotting potential in a stock is no easy task. To be successful, investors need to do their homework well.

It doesn't matter what sort of stock --value or growth -- you choose, experts say; it's more important to understand the business and where it is headed in the next few years.

And if you couple that with the right purchase price, you'll be on your way to mastering the secrets of being a successful stock investor.

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