Like Baskin-Robbins, Wall Street has no shortage of investment flavors when it comes to stocks.
Simply put, common stocks are securities, sold to the public, that constitute ownership in a corporation. They come in all sizes—you can invest in a mega-company or a micro-cap company that has just begun to soar. While some individuals prefer to invest in well-established companies, other investors prefer investing in smaller, growth-oriented companies. No matter what type of company fits in with your overall strategy, it’s important to research every potential stock you buy. Just because a company has been around for decades doesn’t mean it’s the best investment vehicle for you.
Companies are always changing, and it’s important to make sure that the information you are reviewing is current. Mergers and acquisitions have practically become commonplace, and it’s essential to know if a company you are considering buying is undergoing, or is planning to undergo, such a transaction.
It’s also a good idea to research a company’s market capitalization. The market value of all outstanding shares of a particular stock is synonymous with its market capitalization (or cap). Market capitalization is calculated by multiplying the market price by the number of outstanding shares. The number of outstanding shares refers to the number of shares that were sold and are, therefore, now shares outstanding. Larger companies will usually have a lot more outstanding shares than their smaller counterparts. Shares that are issued are outstanding until they are redeemed, reacquired, converted, or canceled.
A public company with 20 million shares outstanding that trade at $40 each would have a market capitalization of $800 million. Although there are no concrete rules to categorize stocks, they can be differentiated by the following:
Large-cap: $5 billion and over
Mid-cap: Between $1 billion and $5 billion
Small-cap: Between $300 million and $1 billion
Micro-cap: Below $300 million
There are also different categories of stock, which suit almost every personality. The variety includes blue-chip, growth, small-cap, cyclical, defensive, value, income, and speculative stocks, and socially responsible investments (SRI).
Blue Chip Stocks
These are considered to be the most prestigious, well-established companies that are publicly traded, many of which have practically become household names. Included in this mostly large-cap mix are IBM (NYSE: IBM), Disney (NYSE: DIS), and Coca-Cola (NYSE: KO). A good number of blue-chip companies have been in existence for more than twenty-five years and are still leading the pack in their respective industries. Since most of these organizations have a solid track record, they are good investment vehicles for individuals leaning to the conservative side when stock picking.
Growth Stocks
As the name suggests, growth stocks comprise companies that have strong growth potential. Many companies in this category have sales, earnings, and market share that are growing faster than the overall economy. Such stocks usually represent companies that are big on research and development. Earnings in these companies are usually put right back into the business. Growth stocks may be riskier than their blue-chip counterparts, but in many cases you can also reap greater rewards. Pioneers in new technology are often growth stock companies. In recent years, growth stocks have outperformed value stocks. That has not been the case at times in the past, and the trend may well turn around in the future.
Small-Cap Stocks
This category comprises many of the small, emerging companies that have survived their initial growing pains and are now witnessing strong earning gains with expanding sales and profits. A small-cap stock today may be tomorrow’s leader—it can also be tomorrow’s loser. Overall, such stocks can be very volatile and risky.
Large-Cap Stocks
Large-cap stocks are a broad subset of the stock market. Generally considered integral to an investor's diversified portfolio, they tend to have fairly similar characteristics and so are grouped together. As a whole, large-cap stocks are an important part of the economy and therefore essential to asset allocation.
Larger companies tend to have a more established business presence and less uncertainty in sales or profits than smaller (small-cap) companies. Although there are exceptions, larger companies often have slower growth rates, but are less risky investments than many smaller companies. Large-caps are considered long-term investments, and 50+ years of historical market returns yield slightly lower than short-term returns, but with less volatility.
Cyclical Stocks
Companies with earnings that are strongly tied to the business cycle are considered to be cyclical. When the economy picks up momentum, these stocks follow this positive trend. When the economy slows down, these stocks follow, too. Cyclical stocks would include companies like DaimlerChrysler (NYSE: DCX) and United Airlines (NYSE: UAL).
Defensive Stocks
No matter how the market is faring, defensive stocks are relatively stable under most economic conditions. Stocks with this characteristic include food companies, drug manufacturers, and utility companies. For the most part, you can’t live without these products no matter what the economic climate may be at any given time. The list of defensive stocks includes Merck and Co. (NYSE: MRK) and Johnson and Johnson (NYSE: JNJ).
Value Stocks
Such stocks look inexpensive when compared to earnings, dividends, sales, or other fundamental factors. When there is a big run on growth stocks, value stocks may be ignored. However, many investors believe that value stocks are a good deal given their reasonable price in relation to many growth stocks. Warren Buffet would probably vouch for that.
Income Stocks
Income stocks, which include REITs (Real Estate Investment Trusts), may fit the bill if generating income is your primary goal. One example of an income stock is public utility companies because such stocks have traditionally paid higher dividends than other types of stock. As with any stock, it’s wise to look for a solid company with a good track record.
Speculative Stocks
Any company that’s boasting about their brilliant ideas but doesn’t have the earnings and revenue to back it up would be classified as a speculative stock. Since these companies have yet to prove their true worth, they are a risky investment.
Socially Responsible Stocks
Another investment strategy that is growing in popularity is socially responsible investing (SRI). Here, investors put capital into companies that represent their personal values. Such individuals may avoid tobacco or liquor companies or any company with products or services that damage the environment. Socially responsible investors favor companies that have a positive influence on society.
Preferred Stocks
Although it is a much less popular alternative to common stock, you can also purchase what is known as preferred stock. These stocks share more in common with bonds than they do with common stock. Essentially, this type of stock has a fixed dividend and a redemption date. Income received has nothing to do with the company’s earnings. If the company goes under, holders of preferred stock have priority when it comes to dividend payments. You normally have no ownership as a preferred stock owner; however, it can be a viable option for income-oriented investors. This book will concentrate on common stock because, like its name, it’s the far more common choice for stock investors.