Stock Market Basics: Types of Stocks

There are many different types of stocks which can be invested in based upon your financial position, your risk comfort level, and your investment goals. In order to determine which type to invest in, you have to first determine what you want the stock to do for you. Do you plan to hold the security long-term, or are you a day trader? Are you looking for capital gains in your investments or is income your main objective? How you answer these questions will give you a good idea of which type of stock you should be considering for your portfolio.

Common Stocks and Preferred Stocks
A company’s stock offerings generally fall into one of two categories: common stock or preferred stock

Common stock represents the basic equity ownership in a corporation. For total return (dividend income and capital gains), no publicly traded investment offers more potential over the long term than common stock. Stockholders are entitled to vote for directors and other important company matters. They also participate in the appreciation of share values and in any dividends declared from corporate earnings that remain after debt obligations and preferred stock dividends are met.

Preferred stock is an equity which has characteristics of both bonds and common stock. Because it is not debt, however, it still carries more risk than bonds. The dividends on preferred stock are usually a fixed percentage of the par, or face, value. Thus, like bonds, shares are sensitive to interest rate fluctuations. Prices go up when interest rates go down, and vice versa. Preferred dividends are not a contractual obligation of the issuer, however. Although, as stated previously, they are payable before common stock dividends, they can be skipped altogether if corporate earnings are low. Also, if the issuer goes bankrupt, though the claims of preferred stockholders come before those of common stockholders, neither will share in any liquidated assets until bondholders are paid in full, because bonds are debt.

Classes of stock
Companies often issue different classes of their stock. The different classes may have different varying voting rights, dividends, or other characteristics. This is very common with preferred stock. Often, if you look at a large companies preferred stock listing they will have a "Series A", "Series B", etc.

Common stock also sometimes comes in different classes. Many times the reason for different classes of common stock is to create a class of common stock that has less voting rights then another class while still having access to capital. For example, there may be a Class B shares that only have 1/10th of the voting power per share than the class A shares, which management owns.

The ticker symbols for the different classes of common stock are typically separated by a period. Viacom is an example of a famous company that has different classes of common stock. The most popular version that investors buy is the Class B shares which are quoted under the ticker symbol "via.b".

Berkshire Hathaway is another example of a famous company with multiple classes of common stock. The reason they chose was because they decided to never split their stock. Because of this the price of 1 share of their stock now costs $112,000 to buy (as of August 2007). Therefore they created Class B shares that have a value of 1/30th of the original shares (now Class A) and 1/200th of the per-share voting rights. The tickers for the different classes of Berkshire Hathaway stock are "brk.a" and "brk.b".

General Stock Types
Listed below are several types of stocks which are commonly traded in the securities market:
  • Blue chip stocks are stocks of well-established companies that have stable earnings and no extensive liabilities. They have a track record of paying regular dividends, and are valued by investors seeking relative safety and stability. The name comes from the blue-colored chips in the game of poker, which are typically the most valuable.
  • Penny stocks are low-priced, speculative and risky securities which are traded over-the-counter (OTC); i.e. outside of one of the major exchanges.
  • Income stocks offer a higher dividend in relation to their market price. They are especially attractive to investors who are looking for current income that will gradually grow over the years as a way to offset inflation.
  • Growth stocks are securities which appreciate in value and yield a high return. Their profits are typically re-invested to expand the business. Investors gain because the stock prices increase as the business grows, thus increasing the value of the investment. Typically, these companies have high P/E ratios because investors expect high growth rates for the near future. Note, however, that growth stocks are risky. If a growth-oriented company doesn't grow as fast as anticipated, then its price will drop as investors lower its future prospects with the result that the P/E ratio declines. So even if earnings remain stable, the stock price will decline. Another risk is bear markets—growth stocks will tend to decline much more than blue-chips or income stocks in a declining market, because investors become pessimistic, and will sell their stocks, especially those that pay no dividends. One of the main benefits of growth stocks is that capital gains, especially long-term gains where the stock is held for at least 1 year, are generally taxed at a lower rate than dividends, which are taxed as ordinary income.
  • Value stocks are securities which investors consider to be undervalued. They feel that the stock is being traded below market value, and they believe in the long-term growth of the issuing company.
  • Cyclical Stocks are the securities moving in accordance with the cycles of the economy. For instance, when the economy is in recession, the cyclical stockholders will suffer the negative effects.
  • Seasonal Stocks represent the securities with featured performance fluctuates with the seasons. For example, retail companies' sales and profits often increase at Christmas and the opening of the school year.
  • Defensive Stocks are the securities representing stable and non-volatile companies. They are preferred in both bad and good economic times, since no matter what the economy conditions are, people will still continue to purchase goods and services. When consumers and businesses cut back spending, a few other businesses profit, either because they offer a way to cut costs, or because they have the lowest prices. For instance, during the credit crisis of late 2008 and early 2009, people tried to save by doing more for themselves. For instance, many people starting cutting hair for their families, or coloring their own hair to save the $200 that some beauty shops charge. This increased business for businesses that manufactured hair cutters and coloring kits. Auto repair shops tend to do better, because people cut back on the purchase of new cars, but cars nowadays are too complex for most people to fix on their own. And while most retailers were hurting significantly during the credit crisis, Wal-Mart was one of the few that actually thrived, since Wal-Mart is usually recognized as providing lower prices than other retailers.
  • Speculative stocks are the stocks of companies that have little or no earnings, or widely varying earnings, but hold great potential for appreciation because they are tapping into a new market, are operating under new management, or are developing a potentially very lucrative product that could cause the stock price to zoom upward if the company is successful. Many Internet companies were considered speculative investments. During the stock market bubble of the latter half of the 1990's, many of these stocks had ridiculous market capitalizations, and yet, many of them had virtually no earnings, and many, if not most, have since then, imploded. A few, such as Amazon, have grown to become major corporations. Many speculative stocks are traded frequently by investors—or some would say, gamblers—in the hope of making a profit by timing the market, since speculative stocks range wildly in price as their perceived prospects constantly change.
  • Initial Public Offering (IPO) are the securities available to be sold to the general public for the first time in order to help generate assets to finance the company’s growth.
  • Penny Stocks over-the-counter bulletin board (OTCBB) or pink sheet securities are low-priced, speculative stocks that are very risky and are not suitable for every investor. They are issued by companies with a short or erratic history of revenues and earnings. Penny stocks sell for less than $5 per share and their companies have under $2 million in net tangible assets. Therefore, the companies do not qualify to trade on the New York Stock Exchange or on the Nasdaq. Instead, the securities are traded by specially registered Dealers. Quotes for the securities are frequently outdated or delayed and may not be firm. Trades for these securities are always executed on a manual basis. The appeal of penny stocks comes from their low price. Though the odds are against it, if the company that issued them suddenly finds itself on a growth track, their share price can rise rapidly. Investors who trade these securities are speculating as to the company's growth and are willing to assume the entire loss of their investment.
  • Gold stocks are the stocks of gold-mining companies. Their value moves up or down with the price of gold.
  • Treasury stocks are stocks that have been bought back by the company that issued them. Companies may buy their stock back from investors when they believe it is underpriced on the market. The company can then set aside the stock for future uses such as debt payment or the awarding of stock options. 
Market Capitalization
Sometimes stocks are categorized by their market capitalization, or market cap.
Market Capitalization = Stock Price x Number of Stocks Outstanding
While the divisions are indistinct, and will depend on inflation, a large-cap company is one with a market cap greater than $5 billion; a mid-cap company, $1 - $5 billion, and small-cap companies are valued at less than $1 billion. Many of these companies can be found by looking at the components of the various indexes, such as the Russell Indexes.
  • Large-cap stocks consist of the blue-chip, income, defensive, and cyclical stocks, since large companies have little potential for growth. Capital gains can be earned, however, by buying these stocks at the bottom of a business cycle and selling them as the economy reaches full speed. Large-cap stocks have the best price stability and the least risk.
  • Small-cap stocks are small companies that have the greatest potential for growth—hence, most of these stocks are growth or speculative stocks, and most tech stocks are also in this category, since many tech companies specialize in a narrow niche of the market, or they were started to develop a new product or service, such as the many Internet companies that sprouted during the stock market bubble. In some cases, the small-cap stocks are distinguished from the even smaller micro-cap stocks, such as can be found in the Russell Microcap Index. Note that even the micro-cap stocks include only those stocks that are listed on major exchanges—they do not include OTC bulletin board securities or pink sheet stocks, which do not satisfy the requirements to be listed on a major exchange.
  • Mid-cap stocks are composed of most of the categories listed here, since their market caps range from the top of the small-cap market to the bottom of the large-cap market. A particular kind of mid-cap stock are the baby blue-chip stocks, which are stocks of companies that, like the blue-chip companies, have consistent profit growth and stability, and low levels of debt, but are smaller in size than the large-cap blue-chips.

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