The right categorisation of stocks is crucial for building a well-diversified portfolio. The idea is to pick stocks from the maximum possible buckets depending on their suitability.
What are the types of shares?
Stocks can be placed in different categories based on their size, ownership pattern, voting rights and fundamental attributes.
Types of share based on their size are:
Largecap stocks: They are the top 100 listed companies based on their full market capitalisation. Market capitalisation simply denotes the market value of all equity shares of a company. Large-cap stocks are actively traded and thus liquidity on these counters is pretty high which helps you buy/sell them in large quantities without much impact on the cost.
Largecap stocks are also famously known as bluechip stocks. They provide stability to any portfolio since they can withstand a challenging business environment given their large operation and robust financials. Investors with a moderately-high risk appetite should have more allocations to Large-caps.
Examples of large-cap stocks*: Reliance Industries, HDFC Bank, Infosys, and Larsen & Toubro to name a few.
Midcap stocks: They are the next 150 companies—ranging from 101st to 250th company—on full market capitalisation. They are smaller than Large-caps but usually have higher growth rates. Investors with a high risk appetite prefer higher allocations to Mid-cap counters hoping that they might become large-caps in future.
Examples of midcap stocks*: TVS Motor, Canara Bank, Aarti Industries, Jubilant Foodworks
Smallcap stocks: Any stock beyond the first 250 companies on the full market cap is a Small-cap stock. However, last 250 companies of Nifty 500/BSE 500 index are usually considered as the most prominent Small-caps. Smallcaps are considered to be agile businesses that can accelerate growth and transform themselves into bigger companies in future. But their prospects can be susceptible to economic shocks and business downturns.
Smallcaps are suitable for investors with very high risk appetites, while those with a moderately-high risk appetite are usually better off avoiding any allocation to them.
Examples of smallcap stocks*: KEI Industries, Bharat Dynamics, Tejas Networks, Carborundum Universal
(*Examples of different categories of stocks are purely for the better understanding of the topic under discussion and shouldn’t be construed as stock recommendations under any circumstances.)
Penny stocks: Tiny, less researched and lesser-known companies which are vulnerable to price manipulations due to their tiny size and questionable management practices are known as penny stocks. They are highly risky and unless you completely understand the risks involved, it would be prudent to avoid any exposure to them.
Type of shares based on their ownership and voting rights
Equity shares/common stocks: Equity shareholders are part owners of a company and they get a right to vote in important decisions of the company concerning the interest of shareholders. What we normally refer to as ‘shares’ are equity shares or common stocks.
DVRs (Differential Voting Rights): The only difference between equity shares and DVRs is that they usually come with fewer voting rights. Meaning, an investor of DVR doesn’t get an equal say in the company’s corporate decisions requiring shareholders’ approval. They usually command lower prices and pay higher dividends to compensate for this differential treatment. In most cases, DVRs are issued to keep off hostile takeovers.
DVRs aren’t commonly found in India but a few companies such as Tata Motors and Jain Irrigation have issued them.
Preference shares: Preference shares or preferred stocks accord investors a right to receive dividends (usually at a fixed rate) before equity shareholders do. Moreover, on the winding up of business operations, the claims of preference shareholders on capital repayments take priority over that of equity shareholders.
Preference shares come in many forms—convertible, non-convertible, cumulative, non-cumulative, redeemable, non-redeemable, participating and non-participating amongst others. Depending on the specific capital requirements of the business, companies decide the terms of preference shares. Non-convertible, non-cumulative and redeemable is the most prevalent combination that companies follow in the normal course of business.
Types of stocks based on fundamental attributes
Stocks can be classified according to their growth rates, valuations, dividend payment record, sectors and themes they belong to amongst others.
The subcategories include
Different stock categories and their risk profiles
|Criterion||Category||The most crucial attribute||Risk profile|
|Size||Large-caps||Large and stable companies. Can withstand economic uncertainties||Moderately high|
|Mid-caps||Smaller than Large-caps but grow faster. Have moderate revenues and profits||High|
|Small-caps||Smaller companies with relatively smaller revenues and fragile balance sheets. Not immune to shocks||Very high|
|Penny stocks||Tiny, less-researched companies with less transparent management||Too risky to own|
|Ownership||Equity shares/common stocks||Offers a part ownership and at-par voting rights||Risky|
|DVRs||Shares are issued at|
discounted price and pay higher dividends: a compensation to forgo at-par voting rights
|Preference shares||Investors get preferential treatment on dividends and capital repayments||Moderate risk|
|Fundamental attributes||Growth stocks||They are high-growth companies and often command rich valuations||High risk|
|Value stocks||They are available at discounted valuations as compared to their true worth||Moderately high risk|
|High dividend yield stocks||These companies distribute a large part of their earnings as dividends. Usually demonstrate low to moderate growth||Moderately high risk|
|Cyclical stocks||Their prospects are closely linked with the country’s economic prospects||Very high|
|Non-cyclical/defensive stocks||They are relatively less vulnerable to economic ups and downs||Moderately high risk|
Knowing the right categorisation of stocks is a prerequisite for effective portfolio management. Depending on the economic growth trends, corporate profitability, stock market valuations, your goals, risk appetite and time horizon, you can decide which categories of stocks you should invest in.
The blog is for information purposes only and anything mentioned herein shouldn’t be construed as a fundamental reason to buy/hold/sell any stock. Furthermore, the information provided in the blog and observations made therefrom shouldn’t be treated as the extension of recommendations made on the other properties of Ventura Securities. If you follow any research recommendations made by our fundamental or technical experts, you should also read associated risk factors and disclaimers.
We strongly suggest you to consult your financial advisor before taking any decision pertaining to your finances. Asset allocation becomes extremely relevant.
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