Different Types of Stocks To Invest In: What Are They?
Different Types of Stocks To Invest In: What Are They?
14 October 2022
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When people hear the word “stocks,” the idea of publicly-listed shares that are traded on the stock exchanges is usually the first thing that comes to their mind. But the number of stocks available for investment and trading is much bigger than that. Each type has its own unique features that make it suitable for different investment approaches. Here we describe the main stock categories in order to give you a clear understanding of what they can be.
Common Stocks and Preferred Shares
Common stock, also known as an ordinary share, is a security that represents ownership in a company. It gives its holder a right to get a part of the generated profit, which is usually paid in dividends. Common shareholders take part in electing the company’s board of directors and in voting on corporate policy. Common stocks are usually distributed among the founders and employees of the company.
Preferred stock, or a preference share, gives its holder the right to get regular dividend payments before they are issued to common stockholders. Preferred shareholders also have a priority right to get part of the company’s assets, in the case of the company’s liquidation or bankruptcy, before common share and other debt holders. Voting rights are not granted by this type of stock, which suits those investors who prefer to get reliable passive income.
Some companies may issue both common and preferred stocks. But most of them offer only common stocks. To put it another way, it is a necessity for a company to issue common stocks, but the decision of whether to issue preferred ones remains optional.
Common vs. preferred stock class comparison:
• Gives the right to vote
• Has more potential for long-term consistent returns
• The price is less volatile
• Preferable in the case of company liquidation
• Dividends are usually fixed and guaranteed
• The price is more volatile
• Dividends are usually neither fixed nor guaranteed
• Less preferable in the case of company liquidation
• Doesn’t give the right to vote
• Has less potential for long-term growth
More suitable for
• Those with a longer planning horizon
• Those who look for passive income
Stock Classification Based on Market Capitalization
The market capitalization of the company is the second basis for stock classification. It is the total market value of the company, which is calculated by multiplying the current stock price by the total number of outstanding shares on the market. The kinds of stocks in this classification can be the following.
Stock can be considered large-cap when the public company’s market capitalization exceeds $10 billion. Such a tremendous size gives the company a bigger influence on the market, letting it seem more sustainable and less risky, as it has enough financial resources to overcome market turbulence.
One of the main disadvantages of large-cap shares is their pace of growth, which is slower than that of newer and smaller companies. It means that you shouldn’t expect huge returns from investments in such corporations.
Mid-cap stock belongs to companies with a market capitalization between $2 and $10 billion. It offers a unique combination of large-cap stability with the growth potential of smaller businesses. They can grow because of getting a greater share of the market or through mergers and acquisition processes initiated by large-cap companies.
Small-cap stock market capitalization ranges from $300 million to $2 billion. This is the largest capitalization class on the market.
Small-cap stock has the largest growth potential, as many of these companies become mid-cap or even large-cap really quickly. At the same time, these shares are one of the riskiest investments, as they are much more vulnerable to market volatility, which may lead to either impressive gains or major losses.
Growth Stocks and Value Stocks
One more stock classification method is based on what the investors are looking for.
Growth investors prefer companies that may demonstrate a quick rise in sales and profits.
Growth stock seems to be riskier, but the returns they may generate usually outweigh the risks. The success of growth stocks is defined by such factors as strong demand for business products or services among its customers, which may be supported by social trends through public approval of corporate activities.
As the number of growth companies is really high, competition between them is fierce. When rival businesses become more successful, the company’s stock price can fall sharply.
A mere growth slowdown can make investors sell their shares, as they may fear that the potential for growth has reached its limit; this leads to a price decline.
Value investors choose those companies whose price of shares is low compared to their intrinsic value, their peers, or their own past stock price.
Value stocks are considered to be a more conservative type of investment, as they represent well-known market leaders who have an established share and don’t have much space for further growth. Still, their business models have proved their ability to develop in a sustainable way, and the stocks of such companies can be a good investment choice for those who prefer price stability.
Domestic Stocks and International Stocks
Stock location is another principle for their categorization. In order to distinguish domestic stocks from international ones, it is necessary to find out where the company’s official headquarters is located.
At the same time, one should keep in mind that a stock’s geography doesn’t always correspond to the country or countries where the company operates and sells its products. This notion is mostly related to big corporations with a multinational presence: their business operations and financial metrics usually don’t tell for sure if a company is domestic or international.
Cyclical Stocks and Defensive Stocks
The cyclical nature of the economy gives another stock classification pattern.
Cyclical stocks are the stocks of companies whose sales and, respectively, share prices coincide with economic conditions: they grow when the economy is growing and fall when the economy is in crisis. The prices of such stocks usually depend on the discretionary spending of the population, which includes spending on retail, dining, travel, and technology.
Defensive stocks (non-cyclical stocks), in turn, usually don’t relate to economic ups and downs. This becomes possible because their revenue is steady during both periods of economic growth and crises. They include utilities, healthcare, and consumer staples stocks.
People tend to invest in cyclical stocks when they are waiting for the economy to grow and in defensive stocks when they believe an economic decline is forthcoming. This approach, known as sector rotation, can be rather risky, as no economic prediction has 100% accuracy.
Blue-Chip Stocks and Penny Stocks
The level of risk can also be a basis for stock categorization.
Blue-chip stocks are considered safe stocks, as they offer sustainable returns and regular dividends. Still, despite the fact that there is no one generally accepted definition of blue chips, these companies have several features in common: large market capitalization, a well-known brand name, a long history of performance, steady earnings, and regular dividend payouts. Such characteristics proving their reliability usually lead to higher share prices. And you shouldn’t expect booming growth of such stocks.
Penny stocks are a much riskier type of investment that may be outright fraudulent. The name itself implies a very cheap valuation.
Companies that belong to this stock category are usually facing financial troubles, or their whole business is collapsing. Penny stocks are traded over the counter, not on major stock exchanges, and usually have a value below $5 per share. It leads to small trading volumes and high liquidity. All sorts of scammers use this tool to fool inexperienced investors.
Dividend Stocks and Non-Dividend Stocks
Dividend payouts to the shareholders give us another type of stock classification.
Many stocks pay dividends on a regular basis, which is a valuable source of income for many investors. The demand for dividend stocks is high among certain financial communities.
However, dividend payouts are not obligatory. Not every blue-chip company pays them. Non-dividend stocks can be a good investment idea in case their share prices grow over time.
In order to get access to public stock markets, private companies have to make an initial public offering (IPO). This process includes listing the shares on an exchange.
The IPOs of some companies are an exciting event, and many investors are waiting for them. Still, it is not always a guaranteed success, and risk assessment is a must. The share of the American companies that were able to generate profit after their IPO has been going down on a yearly basis from the peak figure of 81% in 2009. In 2020, this figure was only 22%.
ESG stands for “environmental, social, and governance” concerns. These three aspects are becoming more and more important for new investment approaches. Instead of focusing entirely on profit and revenue, investors start to think about how the income is generated and what impact on the environment and society the company has.
Investors use ESG principles to estimate the companies in order to understand whether they match up to the necessary values. This approach is designed not only to cut financing for those who fail to match but also to motivate companies to do their best in order to make our world a better place.
Main Stock Market Sectors
Stocks can be divided into categories according to the industrial sector they are working in. The largest of them include the following.
Communication – cellular, internet, media, entertainment
Consumer discretionary – retail, car producers, travel, public catering
Energy – downstream, midstream, upstream, and vertically-integrated energy companies, electricity providers
Finance – banking, fiscal services, insurance
Healthcare – drug and medical device producers
Industry – air, aerospace, defense, agriculture, heavy machinery, roads, railroads, construction
Materials – mining, woodworking, construction materials, chemical companies, packaging
Real estate – real estate investment trusts, management and development companies related to real estate
Technology – IT sector, hardware and software products, communications equipment, and semiconductors
Utilities – electricity, water, gas supply to households
As the technologies are developing very fast nowadays, they are becoming an essential part of practically every sector. As a result, new companies that are represented in two or more sectors appear like, for example, fintech or biotech.
As one can see, the number of stock classifications is really big: they can differ on the basis of what rights they give to their holder, whether their growth is predicted to be fast or sustainable, where the company is located, and where it conducts its business operations. Understanding different types of stocks is the basic knowledge that is necessary for every investor who has started their road in financial markets and needs to make an investment decision.
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