Achieving financial success today is inconceivable without basic knowledge of fundamental investing principles. One can hardly employ investment strategies if they haven’t dived into researching such significant securities as stocks, also known as equities or shares. The stock market has been operating for centuries and is characterized by high volatility, which contributes to more significant income.
Stocks are broken down into multiple categories and classifications. For an aspiring investor, it’s crucial to distinguish between the different types of stocks available on the market. This article outlines the most popular varieties of equities that are always in high demand.
The article covers the following subjects:
Common Stocks vs. Preferred Stocks
A stock is a security that represents an investment in a company. A company has the right to sell the units of its stocks, called “shares,” which are generally issued as either common or preferred stocks.
Common Stocks
Сommon stock is widely considered the most popular stock to invest in, hence the name. It embodies the proof of partial ownership in a company. If the company dissolves in the future, the respective shareholders have the right to get a proportional share of the remaining assets’ value. However, they will always be at the end of the line and will receive the remaining shares (if there will be any left) of the asset only when the holders of bonds and preferred stocks get theirs.
Theoretically, common stocks provide their owners with unlimited upside potential. However, there is a genuine risk of losing the invested money – in the event that the company ceases to exist without any valuable assets left.
Preferred Stocks
Preferred stock is a hybrid security that adopts common characteristics of both bonds and stocks. Even though the holders of preferred stocks don’t own any shares, they receive fixed dividends. The rate of dividend on preferred stocks is either a percentage of the nominal value of shares or an absolute number; it never depends on the company’s revenue. To some extent, preferred stocks are similar to the fixed-income market, and this fact also makes them sensitive to changes in interest rates. That’s why this type of stock is attractive to investors only when the interest rates are stable or about to decrease.
Holders of preferred stocks obtain the pre-emptive right to claim ownership of the asset’s part upon liquidation of the company. These privileges don’t come for free, as investors have to sacrifice their voting rights and are not eligible to participate in the company’s management.
Preferred stock provides its holder with the right to get back a certain sum of money upon the company’s demise. Preferred shareholders are also the first to receive dividend payments; therefore, they are given an edge over common shareholders. Companies typically offer only regular common stocks.
| Common stock | Preferred stock | |
|---|---|---|
| Advantages |
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| Disadvantages |
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| Suitable for | Conservative investors who are interested in long-term growth potential | Investors interested in gaining higher and more stable income |
Classification of Stocks: Company Size
The words “large-cap,” “mid-cap,” and “small-cap” refer to market capitalization, which reflects the actual market value of a company. The market capitalization of a company is calculated by multiplying the number of shares by a share price. Companies are usually divided into three groups by size:
Large-Cap Stocks
Shares of well-established and well-known companies with a market value of $10 billion or more are known as large-cap stocks. The net worth of such companies can exceed the economic capacity of some small countries.
The only downside of large-cap stocks is that their prices are stagnant, as it’s pretty challenging to snowball when you are already an industry giant and lead the respective market. However, they successfully compensate for this drawback by rewarding investors with a sustainable increase of share value in the long run. Here are few examples of well-known large-cap companies:
- Google (GOOG)
- Johnson & Johnson (JNJ)
- Facebook (FB)
Even though investors usually consider large-cap inputs less risky than small-cap ones, conducting thorough research before purchasing any type of stock is a wise decision. Such financial vehicles as mutual funds diversify your portfolio and make it possible to invest in several large-cap entities at once. Thus, you don’t have to spend much time researching individual stocks to make a safe investment.
Mid-Cap Stocks
The shares of medium-size companies with a market value from $2 up to $10 billion are known as mid-cap stocks. These businesses have promising growth potential, so investing in their stocks is less risky than in the equities of small-cap companies.
If you want your investment portfolio to be well-diversified, consider including some mid-cap stocks. Middle-size companies can seem stable, but it’s never redundant to check their track record.
Small-Cap Stocks
The shares of ownership of small companies with a market value from $300 million to $2 billion are known as small-cap stocks. They have tremendous growth potential; however, such stocks expose investors to significant risks during economic downturns. Small-cap businesses lack a reliable financial cushion to help them withstand business depression or bad management.
Growth Stocks vs. Value Stocks
Stocks can also be categorized by the investing style applied to them. The most remarkable equities from this group are growth stocks and value stocks.
Growth Stocks
Growth stocks represent companies that have the future potential to predominate the market. As the name implies, growth stocks never stop growing; once they do, they are no longer growth stocks. If it happens, their share price usually abruptly drops unless the slowdown is considered natural for a maturing company. Very few growth stocks pay dividends, so most growth investors are focused on the rapidly growing share prices.
Investors value growth stocks for their attractive growth rates, but there is always a chance that the stock price won’t follow the company’s growth. Growth in revenue doesn’t always result in growth in earnings.
Value Stocks
Value stocks represent businesses that were misvalued by the market. Their stock price doesn’t accurately reflect the actual value of the company.
The reasons why these stocks were valued incorrectly may vary. For example, value stocks may suffer guilt by association if other companies from the same industry experience a period of major challenges. Investors buy these types of stocks, hoping that the market will someday realize the true value of a company and the stock price will increase.
Value stocks are used to implement a buy-and-hold strategy, providing that investors have enough patience to work it out.
Income Stocks
Income stocks include shares of mature, well-established companies that are steady dividend providers. These businesses don’t always have room for growth; nevertheless, they help shareholders maintain a relatively secure source of passive income. Dividends represent cash payments used by the companies to distribute profits to their shareholders. Regular dividend producers are highly valued among investors for yielding favorable returns.
- Utilities, trustworthy companies that work with basic amenities, are generally assimilated to income stocks for their sustainability.
- Businesses that have income stocks often issue preferred stocks that represent a perfect source of stable dividends.
- Income stocks are top-rated among retired people, who frequently use them to pay for retirement expenses.
- Investors who own income stocks should consider opening a tax-qualified account, e.g., an IRA (individual retirement account). By doing so, the income won’t be immediately taxed.
Classification of Stocks: Location
Stocks can be grouped in accordance with the geographic location of a company. Therefore, diversification of an investment portfolio is possible through investing in domestic and international companies. As for international bonds, you can take into account businesses based in emerging markets that are poised to expand.
US Stocks
Stocks of US companies are known all around the world. They are traded on various stock exchanges and range from the smallest public companies to industry giants, such as Intel (INTC) or Netflix (NFLX).
The most famous and largest stock exchanges in the United States are the NASDAQ, the American Stock Exchange, and the New York Stock Exchange.
Domestic stock funds in the United States enable their investors to operate within the world’s most liquid stock market, thus providing them with a unique opportunity to purchase stocks of the most successful companies in the world. Most US domestic stocks traditionally deliver beneficial returns on a risk-adjusted basis, representing key components of long-term investment portfolios.
When investors buy shares in a domestic stock fund, the invested money is used to purchase equities issued by the domestic businesses. The purpose of mutual funds is to pool stocks of various companies, so investors don’t have to bother buying stocks individually, which would be quite impractical.
International Stocks
International stocks, also known as foreign stocks, are the equities of companies that operate outside the USA. Foreign stocks can be common and preferred, but they are always issued by international corporations with headquarters located outside the United States. Foreign stocks trade worldwide on different exchanges; in the USA, they are traded in the form of ADRs (American depositary receipts).
International stocks serve multiple purposes. For instance, they can strengthen your portfolio by employing diversification or give novel avenues to the rapid growth of returns on investment.
The explosive expansion of international economies increased the productivity of enterprises worldwide, and overall improved living standards will eventually lead to the emergence of such a social phenomenon as a global middle class. These discernible trends anticipate significant economic growth outside the USA. With this information in mind, investors should seriously consider allocating a portion of their portfolios to international stocks.
Classification of Stocks: Market Sectors
Stocks can also be subdivided by the type of industry they belong to. There are 11 basic categories that are in the public eye:
- Utility sector. The companies from this sector are responsible for basic amenities, such as sewage services, natural gas, electricity, water supply, etc.
- Communication services sector. These are media companies that bring the Internet and provide telephone and entertainment services.
- Consumer discretionary sector. This sphere includes companies that sell goods or services of secondary importance, from car manufacturers to hotels and cafes.
- Staple consumer sector. These are businesses that specialize in producing essential goods, such as food, beverages, tobacco products, and many more.
- Energy sector. These are energy market leaders: oil and gas producers, pipeline companies, and petrol station operators.
- Financial sector. This sector refers to banks, mortgage and insurance companies, financial institutions, and brokerages.
- Healthcare sector. These are biotech businesses, medical device producers, and health insurance companies.
- Industrial sector. The industrial companies are in charge of manufacturing aerospace and defense equipment plus construction of railroads, machinery, and other heavy industry items.
- Materials sector. These are producers of mining and forest products, raw materials, and various packaging products. Chemical companies also refer to this sector.
- Real estate sector. This sector unites every imaginable branch of the real estate industry.
- Technology sector. This is probably the most rapidly developing sphere at the moment. Tech companies produce software, hardware, semiconductors, and communications devices, and they provide a large scale of IT services.
Blue-Chip Stocks vs. Penny Stocks
Developing substantial investments is impossible without diversification of your portfolio. It’s vital to consider different types of stocks, including those based on perceived quality.
Blue-Chip Stocks
Blue-chip stocks are market royalty, favorites of the business world. These stocks represent the leaders of the respective industries with immaculate reputations. Blue-chip companies have earned investors’ trust by paying regular dividends for years and have withstood the test of time with honors. Even though equities of blue-chip companies are not about the absolute highest returns, their stability and reliability make them extremely popular among risk-averse investors. Here are few examples of the world’s most prominent blue-chip companies:
More information about blue-chip stocks is in our previous article.
Penny Stocks
In contrast to blue chips, penny stocks represent downscale companies. Their stock prices are so inexpensive that they typically cost less than $1 per share. Penny stocks are prone to dangerous schemes, generally used in speculative business models. Investors are advised to use extreme caution when availing of this type of stock, as it can easily drain their entire investments.
Cyclical Stocks vs. Non-Cyclical Stocks
Periods of prosperity and depression, along with cycles of expansion and contraction, are essential parts of any national economy. Some companies are more open to the influence of these business cycles, while others have a higher resistance.
Cyclical Stocks
Cyclical stocks include shares of businesses dependent on economic downturns and expansions. For example, companies that offer travel services or sell luxury items are the most exposed to risks. This is because a period of economic slowdown deprives their prospective customers of the ability to make expensive purchases. It also works the other way – when the economy is strong, a surge in demand can make such companies rebound sharply.
Non-Cyclical Stocks
Non-cyclical stocks are also called defensive or secular stocks. Unlike cyclical stocks, they are not characterized by impactful fluctuations in demand. A grocery store chain can serve as an excellent example of non-cyclical stock, as people will still buy food even if times are tough. This type of stock shows impressive results as a safe-haven asset during downturns, while cyclical stock will definitely outperform during a bull market.
Dividend Stocks vs. Non-Dividend Stocks
Dividend payments warm the souls of investors, especially if they are paid on a regular basis. However, some types of stocks don’t provide dividends.
Dividend Stocks
Dividend stocks are highly valued among investors who are looking for ways to increase their passive income and make it valuable. In order to qualify as a dividend stock, a company has to pay at least $0.01 per share.
Non-Dividend Stocks
Non-dividend stocks compensate for the absence of dividend payouts with the potential stock price rise over time. Taking into account that even the most prominent companies don’t always pay dividends, this type of stock can be a good investment. However, the current trend is that more stocks tend to pay dividends to their shareholders.
IPO Stocks
IPO (initial public offering) stocks are equities of businesses that recently went private and now offer their shares to the public. IPOs are generally treated as up-and-coming stocks, despite the fact that they may turn volatile. IPO stocks attract the interest of investors even if the investment community has no consensus about their growth and profit potential. A private stock needs at least a year after it becomes available to the public in order to retain its IPO status.
What Are the Best Stocks to Invest In?
Every prosperous investor keeps the existing stock classifications in mind when employing such a helpful technique as diversification. Each type of stock has its own pros and cons, so it’s crucial to adopt a comprehensive approach in order to create a carefully balanced portfolio. It doesn’t matter what stocks you invest in if you are well-informed about companies’ market capitalizations, geographic locations, and different investing styles. It’s essential to consider the stock’s category alongside the company’s growth potential.
While all this information might be a bit overwhelming, Liteforex can easily guide you through the world of finance, helping you to achieve estimated goals and build a viable investment plan.
FAQ On Different Types of Stocks
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.
