Different investors have varying goals when it comes to the subject of investing in stocks. If you’re thinking about doing a stock trade, it is important to know what kind of stock to buy. Are you looking for capital gains? Or would you want to have significant dividend shares?
Do you plan to hold the stock for a long time? Or would you rather buy it at a low price, and sell it immediately when the price goes higher? Understanding the different features of stock types will help you make the correct decision when purchasing stocks.
Two Main Categories of Stock
Basically, there are two main categories of stock. First is common stock, and second is preferred stock.
Common Stock – Buying common stocks means you now own equity in the company. Investors of common stock are entitled to receive dividends and get a profit from the gain in share values. Shareholders also get one vote per share in voting for the board members. Over a long period of time, common stocks, because of capital growth, will yield higher returns than any other investment type. This high return also comes at a price of high risk. If in case the company declares bankruptcy, the common shareholders will not receive any money until the creditors, bondholders, and preferred shareholders are paid.
Preferred Stock – Having preferred stock does not give shareholders voting rights. However, dividends for these type of stocks are declared before common stocks. They will also take precedence over common stock shareholders if in case liquidity is demanded. Preferred stocks have the characteristics of both bonds and common stock. The dividends are in a fixed rate over the par value of the stock.
Different Types of Stock
Blue Chip Stocks – Blue chip stocks are one of the most secure type of stocks available. These stocks come from companies which are profitable, stable, and well-established. Because of the large size of the companies, there is usually no potential for a high growth rate in share price, so most of these stocks give returns in the form of dividends. However, it is possible to earn from these stocks in capital gains during a bear market, when all stock prices are depressed, because eventually the regular price of the stock will return and possibly even higher. Companies that offer this type of stock usually have minimal fluctuations in price as compared to other types of stocks. For investors who are looking for a certain form of security where earning dividends may be a source of income, blue chip stocks may be the most preferable.
Penny Stocks – This is a very low priced type of stock which is often traded over the counter. It has prices of not more than $5 per share to make it affordable to most investors. However, penny stocks carry some of the highest risks and are only suitable to investors with a higher risk appetite.
Growth Stocks – Growth stocks rely on capital appreciation. This type of stocks usually does not declare any dividends since the money earned is going to be reinvested to grow the company. As the business grows, the prices of the stocks are expected to go up as well. The investor can then choose to wait for the right time to sell the stocks he or she bought at a lower price, for a profit. Fluctuations are common among growth stocks and this may not be suitable for risk averse investors.
Income Stocks – This stock is the most suitable for conservative investors who are seeking to gain a profit through dividends. This stock offers a higher dividend in relation to their market price and it has less price fluctuation than other stocks. Investors may also want to acquire income stocks as a way to beat inflation. The unique thing about income stocks is that unlike the fixed interest of bonds or preferred stocks, dividend earnings will grow continuously, year after year, as the earnings of the company grows as well. Most of these companies are already very large, and may even be considered as blue-chip companies, such as General Electric.
Value Stocks – This type of stocks are what investors deem to be undervalued. They feel that the stock is being traded below market value, meaning they can get the stock on the cheap. Eventually, the company will display long-term growth, and other investors will begin to realize the true value of the company. When stock prices become higher, investors may then choose to sell their stocks for a profit. It is said that Warren Buffet, one of the most famed investors in WallStreet, had a flair for picking value stocks, which eventually earned him his wealth.
Cyclical Stocks – In relation to its name, cyclical stocks ride the waves of the economic cycle. It goes up strongly when the economy is up, and it also takes a dive when the economy declines. These companies are usually the supplier of capital equipment for big businesses or big ticket items such as houses and cars. The best time to purchase these stocks is when the economy is at the bottom of the business cycle, when the stocks are still cheap. When the cycle is up again, it would be profitable to sell them immediately.
Defensive Stocks – On the other hand, defensive stocks are issued by companies that are generally resistant to the fluctuations of the economic cycle. Examples of defensive stocks are companies that are involved in the food and utility business. For example, during the crisis of 2008, many people decided to cut back on spending by doing things themselves. This caused DIY items to sell more, giving more profit to the companies who make them.
Speculative Stock – These are the stocks of companies that have very little to no earnings, or have widely varying earnings. However, despite their low income, these stocks hold great potential for appreciation because they are either tapping into a new market, operating under new management, or currently developing a potentially lucrative product. Speculative stocks are usually traded or “gambled” by investors in the hopes of making a profit by timing the market.
Investing in the stock market can be a complex and tricky game. Choosing which type of stock to invest in would highly depend on how much risk an investor is willing to take. Investors who are looking for security in the stock market would do well with blue chip and income stocks, while risk takers would prefer value stocks, growth stocks and even speculative stocks. For those who do not have a wide knowledge of the stock market, or those who do not have access to inside information, may be better off with investing in safer stocks with relatively secure returns.