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Yes, you can categorize your contacts. Unfortunately, not from your phone. You can log into your Google mail account and categorize your contacts there. You can add custom categories there as well. Once categorized, you can search by category on your phone.
I think you're calling "categories' what Google calls "groups" Are you talking about searching by groups using the stock phone app? I couldn't figure any way to do this. Searching the web indicated that this was impossible with the stock phone app. Eventually, I grabbed an app called "Clix - Group Manager" which works great. It's $0.99, but well worth it. Another huge problem I discovered with the stock phone app is that its searching capability is very limited. There's lots of data contained in the contact entries which can't be search for. This is really a big shortcoming on the part of Google. After struggling with this for a while, I researched available apps and eventually got an app called "Contact Search +". It cost $2.99 and is worth every penny. It really opens up search capabilities on your phone. Ken
You are correct, the stock app does not allow searching or sorting by group. I use Handcent for txt and it allows use of the groups you have set up in y9our google account.