You must have heard of the term stocks. Whenever we talk about investing, it comes up quite often. But what are stocks, what are the different types of stocks, and why is this term important? Let's understand it first.
Simply put, stocks are the shares or equity in a company that will give you a portion of ownership in that company. Companies share ownership of their company with the public in order to raise capital for the further functioning and diversification of the company. When you decide to buy stock, you need to pay a certain amount from which the company will benefit. Once you buy stock, you become a stockholder in that company.
This buying and selling of stocks takes place on special platforms known as stock exchanges. You can consider them marketplaces for trading.
Perks
- Becoming a stockholder comes with certain rights and benefits. You get the right to vote on decisions made by the company. Apart from this, you can also participate in the decision making process on important topics like the merger of your company with another company.
- Sometimes, when companies do well, they directly share their profits with investors to maintain a bond of trust among each other. These earnings can be beneficial to you as they provide an additional income source.
- Stocks also provide diversification, which decreases the risk by offering to invest in several companies. Being a stockholder in one firm, you can invest in as many other companies as you want and become a part of the companies you consider valuable with a great culture.
Risk Factor
- But with all these pros, there are also cons. Investing in stocks is pretty risky as compared to investing in government bonds, etc. Investing needs good research and a long-term perspective because the value of stocks fluctuates and can go up or down over time.
Now that you have an overview of the stock universe, let's delve further at the various types of stocks that you can invest in.
Types of stocks
Investing in the stock market can be rewarding as well as devastating. One should know the different types of stocks available and understand them carefully before investing so that they can know the benefits and risks of stocks. Primarily, there are two main types of stocks- common stock and preferred stock.
1. Common stock
When anyone talks about stocks without any specific details, it generally refers to common stocks. It is the most widely known stock. Through ownership of common stock, you attain a position as partial owners in the company, also called stockholders.
Benefits from common stocks
- Capital appreciation:
It refers to the increase in the value of the stock since the time of purchase. Investors can consider making a profit by selling their shares at a higher price than the purchase cost.
- Voting rights:
Common stockholders usually have the right to vote on certain important corporate decisions. The ownership of an individual shareholder depends on the share he owns in the company, and usually, it is proportional.
Risks Associated with Common Stocks
- Market Risk
Common stocks are impacted by overall request provisions and can be subject to significant price oscillations due to gainful, political, or other convenient factors. Changes in interest rates, economic conditions, or geopolitical events can impact stock prices. Thus, you need to consider market risks before investing in any stock.
- Business Risk
The success or failure of the company directly impacts the value of its stocks, and for investors, the performance of common stocks usually depends on how well the company is doing financially and how promising its business is. If the company makes poor decisions due to bad supervision or faces strong competition, it can directly affect the company's profits and, in turn, the stock price. Therefore, the success or failure of the company directly impacts the value of its stocks and investors.
2. Preferred stocks
Preferred stock is a type of ownership in a company, much like common stock. However, they possess distinctive characteristics that set them apart in the field of investments. Preferred stockholders are considered "preferred" because they have a higher claim on the company's assets and earnings compared to common stockholders.
Once you become a preferred shareholder, you get special perks like getting dividends when the company makes a profit and helps handle the company's financial problems. Preferred shareholders are given priority over common shareholders, as they are paid before common shareholders and receive any dividends or assets if the company faces any difficulty or goes bankrupt.
Types of Preferred Stocks:
Here are some of the most common types of preferred stocks:
- Cumulative and Non-Cumulative:
Cumulative preferred stocks ensure that if a company fails to pay dividends over time, the unpaid dividends accumulate and must be paid before any dividends can be distributed to common shareholders. Unlike cumulative preferred stocks, Non-cumulative preferred stocks do not offer this feature, and missed dividends are lost forever.
- Convertible Preferred Stocks
These allow holders to convert their preferred shares into a certain number of regular shares of the company, providing an opportunity to benefit from potential capital appreciation.
- Callable Preferred Stocks
With Callable preferred stocks, the company grants the power to buy back the shares from investors at a specific price after a predetermined date, offering the company flexibility, but it could mean that investors have fewer options for earning money from these stocks.
Risks Associated with Preferred Stocks:
Preferred stocks give special benefits, but also come with certain pitfalls that investors should be apprehensive of :
- Credit risk
if the issuing company faces financial difficulties or, in the worst-case scenario, goes bankrupt, preferred stockholders may lose their promised dividends or their entire investment.
- Interest Rate Threat
One significant threat is the interest rate risk of a favorable stock price. As fixed-income securities, they may become less attractive to investors compared to other investing options.
- Market Price Volatility
Despite being considered fairly stable as compared to common stocks, they are not shielded from market price volatility. Preferred stocks can still face price fluctuations, and their value may be influenced by market sentiment, demand, and force, which investors should be aware of and prepared for.
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3. Blue-Chip Stocks:
Blue-chips stock is a good choice for investors who want a safer and more stable investment option.
Blue-Chip stocks are issued by well-known companies that have been around for a long time and have an excellent track record of doing well constantly, for example, Apple, Coca-Cola, Microsoft.
Because they are large, well-established, have a history of performing well, and have proven themselves to be trustworthy over the years, blue-chip stocks are considered safer to invest in compared to other companies. There are fewer chances of facing major financial troubles compared to smaller or riskier companies, making it a good choice for investors looking for stable investment options.
4. Growth Stocks:
Any stock in a firm that is expected to increase in value much faster than the market as a whole is considered a growth stock. Growth stocks are an interesting alternative to invest in because, rather than paying dividends to stockholders, companies choose to reinvest their earnings into their own businesses. By using their earnings, these companies fuel their growth even further, which results in higher stock values for the company’s stocks. Now that the value of your stock has grown due to capital gains, you can make a profit by selling it. If the business plans of the company you are investing in work out, then your investment can grow rapidly. For example, think of famous tech companies like Amazon, Facebook, or Google. When these companies were in their growing stages, some of us invested in them beforehand, and that has helped them make money till today from that one big investment.
However, it is crucial to remember that investing in growth stocks can be riskier as compared to other types of investments. Since these companies are focused on growth, they may not pay dividends, which means you, as an investor, need to rely on the increasing value of the stock. If the company's growth plans don't pan out as expected, the stock's value could drop, and you might lose money.
5. Value Stocks:
You can think of value stocks as stocks of a company that are currently trading at a much undervalued price in comparison to the potential of the company. These are similar to end of season sales, which we see once in a while. You need to have an experienced mindset to check out the real worth of a company. Going to the very roots of a company, like earnings, revenue, or cash flow, will help you make the right decisions. Aside from this, you can also use various financial tools like the price to earnings ratio and the price to book ratio to come to a conclusion.
6. Cyclical Stocks
Cyclical stocks are those stocks, which are dependent on the ups and downs of the economy. If the economy of a country is doing well and people are spending money on items, then the value of these stocks will shoot up. Whereas if the economy is facing a rough patch, these stocks perform very poorly. You can use this predictability in your favor by buying these cyclical stocks at low prices when the economy is unstable and selling them later, when things become better, at much higher prices.
7. Defensive Stocks:
Defensive stocks are those that remain strong even in tough times. This stock provides consistent services and products that people always need, regardless of what the economy is doing. So even during an economic downturn when people reduce their spending budgets, these companies still provide essential goods and services like basic food and healthcare to their investors, no matter what the economy is doing. Defensive stocks give you a Shield of stability in your investment.
8. Small-cap stocks
The cap in small-cap refers to the market capitalization of the company. Small-cap stocks are stocks of companies that are currently growing, and their market capitalization lies somewhere between $250 million and $2 billion. Experienced investors look for young companies that are performing well and growing consistently. Researching such companies gives them the chance to play big by investing in these potentially blue-chip stocks of tomorrow. Definitely, these stocks are somewhat riskier than other stocks, but proper research about the companies can lead to fruitful decisions, which can give you lifelong earnings overnight.
9. Mid-cap stocks
As the name suggests, mid-cap companies lie somewhere between small-cap and large-cap companies. In terms of figures, mid-cap companies are those whose market capitalization lies somewhere between $2 billion and $10 billion. Growth is predictable for such companies due to their expanding market size and rising profitability. These companies offer a blend of stability and growth, which makes them useful for portfolio diversity. Financial consultants suggest that having mid-cap and large-cap stocks diversify your portfolio but only mid-cap companies can diversify the risk as well.
10. Large-cap stocks
Yes, you got it right that these are the stocks of companies whose market value exceeds $10 billion. Large-cap stocks are considered the safest among small, mid, and large-cap stocks. But this safety comes at the price of inhibited growth. Generally, small and mid-cap companies offer more growth in comparison to large-cap companies. But still, some of the large-cap companies are very innovative with their strategies and offer constant growth.
If you are looking for a long term investment with a minimal amount of risk, then you should definitely invest in large-cap companies.
Read Also:- Achieve Short Term and Long Term Goals with Strategic Investing
Here is a comparison table of classifications or categories of stocks:
| Classification | Description | Risk Level | Example |
|---|---|---|---|
| Blue-Chip Stocks | Shares of large, stable companies | Low | Apple Inc. |
| Growth Stocks | Companies with high potential for growth | Medium | Amazon.com Inc. |
| Value Stocks | Undervalued stocks with growth potential | Medium | Coca-Cola Company |
| Dividend Stocks | Companies that pay regular dividends | Low | Johnson & Johnson |
| Small-Cap Stocks | Companies with small market capitalization | High | Etsy, Inc. |
| Mid-Cap Stocks | Companies with medium market capitalization | Medium | The Hershey Company |
| Large-Cap Stocks | Companies with large market capitalization | Low | Microsoft Corporation |
Conclusion
Investing in stocks can be rewarding, but one should also understand its pros and cons before making an investment. In this article, we tried to inform you about stocks, the types of stocks available out there, and which companies you can invest in. We also compared stocks and companies so that you can get a clear idea with a quick look. Companies like blue chips are safe and stable to invest in; growth stocks have high potential but are riskier too; and value stocks are hidden gems. Other than these, investing in sector-specific stocks allows you to target your favorite industries. Remember that investing requires proper knowledge of investments and stocks. One should carefully understand the do's and don'ts of investing and gather information before investing. We hope that this article satisfies your interest in reading about investment. In case you have any queries, you can reach out to us.
Have a happy and safe investment!
