Introduction
There are many ways to classify stock: by the type of ownership they represent, by where they’re sold, by when the stock is issued, by size, by style, by how they are affected by business cycles, and by the location of the issuing company. Companies that offer shares of common stock to the public are called public companies. By contrast, private companies may be owned by just one or two persons or a family; closely held companies may be owned by a small group of investors.
The array of choices available may make the selection process seem daunting, but that variety allows you to build a portfolio that’s appropriate for your financial goals. For example, conservative, income-seeking investors might focus on stocks of larger, established companies that pay dividends. Investors who are more interested in the potential for capital appreciation might focus their attention on growth-oriented stocks. With thousands of stocks available globally, every investor has the opportunity to build a diversified portfolio that’s tailored to his or her financial objectives and risk tolerance. Not surprisingly, with so many choices available, the financial services industry has created helpful ways of categorizing and profiling stocks.
Stocks by type
Common stocks
Common stocks, the type most frequently owned by the general public, are shares (or units) that represent partial ownership of a company. Most common stocks can be bought or sold on any business day. Typically, common stocks entitle the holder to voting rights. Some common stocks pay dividends, some do not.
Preferred stocks
Preferred stocks are stocks that pay a fixed rate of return in the form of dividends. That makes preferred stocks more similar to bonds than common equities. A company’s preferred stock does not typically benefit as much as its common stock does if the company’s earnings and profits grow; for example, preferred-stock dividends do not increase. However, some preferred stocks may have a conversion right. Also, most preferred stockholders do not have voting rights in the company, but their claims on the company’s assets will be satisfied before those of common stockholders if the company experiences financial difficulties. Dividends to preferred stockholders also take precedence over dividends to common stockholders.
Unlisted securities
Unlisted securities are common stocks and other securities that are not listed on organized exchanges, like the New York Stock Exchange (NYSE). Instead, these securities trade over-the-counter (OTC). Sometimes referred to as pink-sheet stocks in the days when their listings were printed on pink paper, they are frequently more difficult to research and trade than other stocks. They are generally regarded as high-risk investments.
Penny stocks
Penny stocks are high-risk stocks that sell for less than $5 per share, according to the Securities and Exchange Commission. These may be shares of young companies with short histories, or companies that are experiencing difficult times, either as a result of poor or unstable earnings or because the value of the stock has been affected by expensive litigation or scandal. Penny stocks are also frequently illiquid.
Subscription rights
Rights are securities granted to existing shareholders of a corporation that convey the right (but not the obligation) to purchase shares of a new issue of common stock before it is offered to the public, often at a discount.
Warrants
Warrants are securities usually issued by a company together with bonds or preferred stocks that entitle the holder to the right (but not the obligation) to buy a proportionate number of shares of common stock at a specified price before the expiration date. The warrants can be traded separately from the bonds or stocks with which they are issued.
Stocks by stage of issue
New issues are stocks offered directly by the issuing company to the public for the first time. They help companies raise cash to meet expenses or finance growth.
New issues may be offered by a company that is already public. Initial public offerings (IPOs) are a special type of new issue because a company typically has an IPO only once–the initial time it offers any shares at all to the public. Once an IPO or new issue has been completed, investors buy and sell shares through brokers on the secondary market.
Shares in an IPO can be challenging to acquire for an average individual investor. Only a limited number of underwriters participate in any IPO, and if there is a lot of interest in the company that is going public for the first time and there is high demand for the shares before they’re issued, the shares may be oversubscribed. Also, some brokerage firms limit IPO purchases to a select group of clients.
Stocks by size
A common way of categorizing stocks is by the size of the issuing company. A company’s size is typically measured by its market capitalization–the aggregated value of all outstanding shares of the company’s common stock. The so-called market cap of a company can affect how widely traded a stock is, and it is a key component used in most style box analyses.
Large-cap stocks
Large-cap stocks are shares of large companies whose common stock is widely owned by many individual and institutional investors. Large caps are typically regarded as liquid investments because they are bought and sold frequently and in large volume on the major stocks exchanges. Also, the bid-ask spread–the difference between the highest price a buyer is willing to pay for a share and the lowest price a seller is willing to accept–on a large-cap stock tends to be tight. The market capitalization of large-cap companies generally is $10 billion plus.
Large-cap stocks often pay dividends, and their prices as a whole are generally less volatile than those of small-cap stocks. The stocks of leading businesses with well-known names like Coca Cola, GE, or Wal-Mart are often called blue-chip stocks. The phrase dates back to the 1920s when blue poker chips were more valuable than red or white chips. All blue-chip stocks are large caps, but not all large-cap stocks are blue chip. The 30 companies in the Dow Jones Industrial Average are regarded as blue-chip companies.
Midcap stocks
Midcap stocks are shares of companies that are midway between large-cap and small-cap companies. Typically these companies may have a market capitalization between $2 billion and $10 billion. Midcap stocks also tend to be fairly liquid with generally tight bid-ask spreads.
Small-cap stocks
Small-cap stocks are shares of smaller companies with a market capitalization between $200 million and $2 billion. Small-cap companies are frequently young; they may be growing at a faster rate than mid- or large-cap companies, and they are generally regarded as higher-risk investments as compared to mid- and large-cap stocks. Because small-cap companies may have fewer financial reserves than larger firms, their stock prices are often more affected by changes in interest rates, or economic hard times. Small-cap stocks, as a group, are less liquid than mid- and large-cap companies. For this reason, this asset class is less appealing to institutional investors, and small-cap stocks usually have a higher percentage of ownership by individual investors than large- or midcap stocks do.
Microcap stocks
Microcap stocks are shares of very small companies whose market capitalization is $20 million to $200 million. Microcap companies may specialize in innovative products or services and may be relatively unknown. The shares may be illiquid, trading relatively infrequently on smaller stock exchanges or over-the-counter (OTC). The lack of liquidity results in bigger bid-ask spreads; that increases the overall cost of trading these securities. In addition, large trades can in some cases significantly move the price of the stock. As a result, very few institutional investors invest in microcaps.
Stocks by style
Another common way of categorizing stocks is by the growth profile of the issuing company and the stock’s valuation. Those valuations reflect how much investors are willing to pay for a share of the company’s future earnings, though obviously its previous performance will influence those expectations. The style of the issuing company is the second key component used in style box analyses.
Aggressive growth stocks
Aggressive growth stocks are stocks of rapidly expanding companies believed to have the greatest growth prospects in the marketplace. The lure of aggressive growth stocks is the idea of getting in early on the next big thing. For those aggressive growth stocks that fulfill the hopes of investors, returns can be large. These stocks generally pay little or no dividends because the companies are plowing profits back into the business to expand it. Because of investor belief in their prospects for the future, aggressive growth stocks generally carry the highest valuations. However, if operating performance falls short of expectations, they can also experience significant share price losses.
Growth stocks
Growth stocks are shares of corporations that have above-average growth prospects but whose potential is not quite as dramatic as aggressive growth stocks. Growth stocks typically offer fairly modest dividends, if any, as profits usually are still being reinvested back into the business at a fairly high rate. Growth stocks generally carry above-market valuations, although those valuations are lower than those of aggressive growth stocks. Some investors look for a combination of growth and value, a strategy known as GARP (Growth at a Reasonable Price).
Value stocks
Value stocks are shares that are considered to be selling below their true worth, considering their existing operations, future growth prospects, or current assets. Value stocks can trade at a below-market multiple to earnings, sales, cash flow or book value, or in many cases, several different measures of value per share. The low valuations generally are due to lower historical or expected business performance. For example, companies with flat or declining sales and earnings often have shares that fall into the value category. Value stocks and value investing were popularized by Graham-Dodd in the 1940s and more recently by Warren Buffett. Value stocks may offer above- or below-market dividend yields but generally don’t fall into the top tier of dividend-paying companies.
Income stocks
Income stocks are stocks of companies that offer the highest dividend yields in the stock market. Although the fixed interest rates paid by bonds are most favored by many income-oriented investors, many conservative investors also invest in income stocks because they want the potential for capital appreciation and increases in those dividends. There are also preferred tax treatments for qualifying dividends versus interest income. However, an income stock also may offer a high yield because its operating performance has declined and its share price has dropped. Because the yield is derived by dividing the annual per-share amount paid in dividends by the share price, a drop in share price pushes the corresponding yield figure higher. In these cases the dividend (and resulting dividend yield) may be at risk, not to mention the share price itself.
Stocks by cyclicality
Developed economies frequently show the effect of business cycles, which involves shifts over time between periods of growth and decline. Companies respond in varied ways to business cycles; their sensitivity to business cycles groups them into cyclical and non-cyclical categories.
Cyclical stocks
Cyclical stocks are stocks of companies whose profitability is tied to broad economic trends. These companies’ profits tend to follow economic cycles, rising when the economy turns up and falling when the economy slows down. Examples include companies that offer products or services that do best when consumers or businesses have money to spend on new technology or luxury items, over and above products or services that meet basic needs such as food or essential medical services.
Defensive or non-cyclical stocks
Typically, defensive stocks are stocks issued by companies whose earnings are considered more predictable than those of other companies, or stocks in industries that are widely believed to be less dependent on economic cycles than others. Companies that meet basic needs, like food or essential health-care services, have more protected businesses even if the economy slows.
Stocks by issuer origin
Generally, international stocks are shares of a corporation headquartered outside the United States. International investments may expose investors to fluctuations in currency exchange rates, as well as the ups and downs experienced by the companies offering shares. Also, accounting practices and disclosure regulations in other countries are different from those applied to U.S. companies, which can make stock analysis more difficult. International investments are available in well-established international economies as well as in emerging markets.
There are many ways to invest internationally. An investor can buy shares of international companies that are listed on U.S. exchanges or on overseas exchanges. American Depositary Receipts (ADRs) are another possibility.
American Depositary Receipts (ADRs)
American Depositary Receipts (ADRs) are negotiable certificates that represent shares of a foreign stock. Issued by a U.S. bank, ADRs are denominated in U.S. dollars and traded on U.S. stock exchanges, making it easier for Americans to invest in overseas markets. ADRs are an alternative to direct investment in foreign securities.
Investing is an excellent method to increase your wealth over time, but it’s crucial to recognize that it comes with risks, and there are no guarantees. If you’re a beginner, it can be intimidating and overwhelming to get started with investing. But don’t worry – we’re here to assist you. Scarlet Oak Financial Services can be reached at 800.871.1219 or contact us here. Click here to sign up for our weekly newsletter with the latest economic news.
Source:
Broadridge Investor Communication Solutions, Inc. prepared this material for use by Scarlet Oak Financial Services.
Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on individual circumstances. Scarlet Oak Financial Services provide these materials for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
