How to pick and hold the six categories of stocks :: ET

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Legendary stock market investor Peter Lynch identified six categories of stocks: slow growers, stalwarts, fast growers, cyclicals, turnarounds and asset plays.

Find out the strategy you need to employ to pick and hold these stocks based on their classification:

1. Slow growers: These are stocks of typically large and established companies that are not expected to grow faster than the overall economy. They will rarely yield a big return on investment, but are known to provide regular and hefty dividends. Since there is little scope for expansion, cash is returned to shareholders. These can be identified by a low trajectory of earnings growth, usually 5-7%. Utilities are among the best examples of slow growers.

Action key

These can be good dividend yield plays. The regular dividend payouts can provide a constant stream of revenue.

Do not expect a huge capital appreciation as the earnings growth is muted.

Stocks: Power Grid Corporation, HUL

2. Stalwarts: This category also includes stocks of large companies, but they are able to grow at a fairly fast clip of 10-15% earnings growth. They are able to maintain a decent earnings growth even during downturns, mostly due to the nature of their offerings. FMCG, information technology and pharmaceutical companies are classic examples. Though not star performers, they can generate healthy returns when bought at the right price.

Action key
Should form a part of your core portfolio as they offer protection during bad times and yield decent returns in bull markets.

Since these are usually expensive, buying at the right time is crucial.

Stocks: ITC, TCS, Infosys

3. Fast growers: These mostly include stocks of smallsized firms growing at an aggressive pace of 20-25% a year. They can generate huge returns and even become multibaggers within a relatively short span of time. However, they also carry a considerably higher risk.

Action key

Your portfolio should have 20-30% allocation to these stocks. Go only for companies that have strong balance sheets and are not heavy on debt.

Again, do not overpay for growth. Remember that these can see a steep price fall when growth falters.

Stocks: Page Industries, Motherson Sumi

4. Cyclicals: Companies in this stock basket tend to exhibit inconsistency in revenue growth. They are likely to perform in line with the broader economy or industrial cycle in a predictable pattern. The earnings growth can vary from 5-6% during downturns to 18-20% during upturns. Stock prices also move erratically based on the stage of the economic cycle that the company is passing. The companies in automobile, construction, metals, industrials and banking space are prime examples.

Action key
Timing is everything. You may suffer huge losses if you buy a cyclical stock at the wrong point in the cycle.

Investors must learn to detect signs of a business that is beginning to pick up or they will take a hit. Employ strict stop loss strategy while buying the stock.

Stocks: Tata Steel, Hindalco

5. Turnarounds: This includes stocks that have been badly hammered in the market for a variety of reasons, but are in a position to rebound quickly. The share price can spike if a new company makes strategic investment or a new leader takes over. If you are able to identify a turnaround stock at the right time, you can make outsized returns within a very short span of time. Satyam Computers is the best example of a turnaround stock. Although these stocks have the potential for huge gains, the risks are equally high.

Action key

Keep a close eye on crucial actions by distressed companies. For instance, any meaningful reduction in debt through sale of non-core assets or other means is a positive trigger.

Be very selective. These have the potential for huge gains, but not all troubled firms can effect a turnaround.

Stock: Wockhardt

6. Asset plays: These are stocks of companies that own key assets, which sets them apart from other companies but are mostly overlooked by the market. The firm may have a huge cash reserve that might come in handy during a downturn or may own large real estate that has not been valued properly. However, finding these assets and assessing their value requires good knowledge of the company that owns the assets.

Action key

Patience is key to investing in these companies since it may be a while before the market catches on to them.

Stock: BPCL