The Different Types of Stocks You Can Invest In
If you are new to investing in the stock market, you may feel overwhelmed by the different choices. You have heard concepts like growth and value stocks but have no idea what the difference is.
The best way to become a better investor is to increase your knowledge about the details of the stock market. If you understand all the concepts and types of stocks, you will naturally make more informed investment decisions.
The Different Types of Stocks:
Common Stock
Common stock represents company ownership and is generally what retail investors are purchasing on the public stock market. In the event of bankruptcy, common stockholders will get paid out last if a company gets liquidated.
Preferred Stock
Preferred shareholders prioritize a company's assets more than common shareholders but less than bondholders. As a result, they also may receive a higher dividend yield than common stock.
Growth Stocks
Growth stocks are companies expected to provide returns above the market average. Instead of paying dividends, growth companies reinvest their profits back into the company to grow its share price.
Since growth stocks attempt to increase sales and earnings higher than average, the risk is also higher than the average company. There is always a balance of risk to reward in the stock market. The more risk you take, the more you can potentially make or lose.
Value Stocks
Value stocks are companies trading at a low price concerning their fundamentals. For example, a common metric used by value investors is the P/E (price to earnings) ratio. A low P/E ratio signals a stock’s price is lower than its actual earnings.
Many famous investors, such as Warren Buffett, are notorious for making a lot of money with value stocks. Value stocks generate reliable revenue and usually pay a portion of it as dividends, making them an excellent long-term investment.
Income Stocks
An income stock is a company that offers a consistent income with relatively low risk. The ideal income stock has a dividend rate higher than a bond yield and consistent or slight revenue growth.
Income stocks are best for investors who do not want to take on high risks and prefer consistent dividend income over capital growth potential. The cash flow statement is essential when analyzing an income stock since companies pay dividends using earned cash flow.
Blue-Chip Stocks
A blue-chip stock is a large, well-established company with a strong brand. These companies are usually market leaders in their sector and are well-known household names.
Excellent examples of blue-chip companies include Apple and Coca-Cola. Since these companies have so much brand loyalty, investors turn to blue-chip companies during challenging economic times to weather the harsh market conditions.
Cyclical and Non-Cyclical Stocks
Cyclical companies are also known as consumer discretionary companies and make products that do well when the economy is hot. Non-cyclical stocks are also known as consumer staples and perform well when the economy slows.
Cyclical stocks include companies like restaurants, hotels, designer clothing, and car manufacturers. People are more likely to indulge in these discretionary items when the economy is doing well.
Non-cyclical stocks are companies like Procter & Gamble. Procter & Gamble produces items like shampoo and toothpaste, which are necessities even when the economy is slow.
Defensive Stocks
Defensive stocks provide reliable dividends and revenue regardless of how badly the economy performs. Defensive stocks share many characteristics of value and income stocks. However, investors must understand all of the stock market lingo and terms.
Like all stock market strategies, risk and reward are always tradeoffs. Defensive stocks are risk-averse and will underperform during bull markets but outperform during bear markets.
Initial Public Offering (IPO) Stock
An IPO is a process of taking shares of a private company to the public markets for the first time. An IPO allows companies to raise money from public investors to grow their business efficiently.
Investing in IPOs is risky because there is no guarantee that the investment bank will value it at a price the market believes is efficient. IPOs are also volatile when they first go public since it is the first time public investors can buy and sell shares.
Penny Stocks
Penny stocks are companies whose stock prices trade for $5 or less. Most are not traded on large exchanges and are available in over-the-counter (OTC) markets. While there is a chance of striking significant returns from penny stocks, the risk is equally as high.
Penny stocks are essentially the riskiest play on the stock market since the companies are usually small and illiquid. As a result, investors must be aware of large bid-ask spreads and volatility when trading penny stocks.
ESG Stocks
Environmental, social, and governance (ESG) stocks are companies that engage in ethical principles. For example, companies that ensure their products and services are environmentally friendly regarding toxic waste and greenhouse gas emissions.
Additionally, the company should value its employees' health and safety to meet social standards. Finally, ESG stocks follow governance standards to ensure a company uses accurate accounting methods and avoids conflicts of interest.
Large Cap Stocks, Mid Cap Stocks, & Small Cap Stocks
Large cap stocks refer to companies with a market cap of $10b or more.
Mid cap stocks refer to companies with a market cap between $2b and $10b.
Small cap stocks refer to companies with a market cap of less than $2b.
Types of Stocks: Bottom Line
All investors must be aware of the various types of stocks available on the stock market. Even if you do not plan on investing in a specific stock, it is helpful to understand its concept in case you see an opportunity in the future.
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As Always: Buy things that pay you to own them.
-Josh
Blog Post: #056
