The 4 Different Types of Stocks
Ok, I lied, there are many different types of stocks depending on what you look at. You can define stocks based on Ownership rights, Size, and Investment Type. I want to focus on Investment Type, but let's define the other two first.
In terms of Ownership Rights, there are
- Common stock: When you buy a “share” of a publicly traded company, you are buying common stock. This is just a piece of a company that usually has voting power. The more shares you own, the more of the company you own. In terms of dividends (or money paid out to its owners), the company is not obligated to pay them out and if they do pay dividends, they can fluctuate at the company’s discretion.
Preferred stock: Preferred stock isn’t that common (excuse the pun) for publicly traded companies and it is usually sold in special situations for special investors, such as in the height of the housing crisis of 2008, Warren Buffett bought preferred stock in Goldman Sachs to keep them afloat. These shares have fixed dividend unlike common stock and are paid before common stock.
In terms of Size, companies are categorized by Market Capitalization (referred to as Market Cap or just Cap). Market Cap is just one way to value a company. It is the number of shares outstanding multiplied by the price per share. The main categories are:
- Large-cap: Over $10 billion
- Mid-cap: $2 to $10 billion
- Small-cap: $250 million to $2 billion
- Micro-cap: Below $250 million
In terms of Investment Type, which is what I wanted to focus on in this article, the main categories include:
- Blue-Chip Stocks: these are usually large-cap companies that you’ve probably heard of such as IBM, General Electric, and Apple. They are the safest companies to invest in because they usually have a long operating history with steady profits. For this reason, they don’t have much room to grow.
Income Stocks: These are generally large or mid-cap companies with long histories of paying large dividends to its shareholders. The most typical example of these is utility and energy companies. As with Blue-chip stocks, these usually don’t increase in value that much. Older people may rely on these because they are a stable source of income.
Value Stocks: These are sometimes referred to as “cheap” stocks. They can be underpriced because of financial problems or seasonal trends or any other market conditions. Be careful with this. It does not mean that since the stock price of Microsoft is lower than that of IBM, Microsoft is cheaper. You have to look at the ratios! Like Price to Earnings (P/E) Ratio, Price to Sales Ratio, Price to Cashflow ratio, etc. Learn more about ratios in Part 3 of my article series, How To Become an Investment Ninja.
- Growth Stocks: These are companies that are growing quickly, but are relatively small in size compared to their peers. Because of this, they can be very volatile. Their stock price can go up just as fast as it can drop.
So what does it mean?
Depending how much risk you can tolerate (i.e. how much you can take your stock going up and down) you can choose any combination of these different types of stocks.
For example, a young person might prefer growth stocks since they can increase in value faster than Blue-chip stocks, but they can also decrease in value just as fast. They can tolerate that risk because they have all their lives to make that money back. Compare that to a widowed elderly woman who chooses Blue-chip stocks and income stocks because she prefers a more stable source of income so she can take care of herself.
So are you an elderly widowed woman or a young person? Age is just a number, you say? Well yeah, but you should still know your own investment goals and limitations. Do you want to grow massive wealth and can handle tons of risk? Or do you prefer to preserve your net worth and are ok with modest growth? Maybe you’re somewhere in the middle? Before you pick a stock or any type of investment, you should first consider if it fits your investment profile. It’s not that complicated, but there is always a tradeoff between risk and reward. Want to learn more?