If you’re the type who currently invests in individual stocks, or you plan to start doing this in the future, it’ll be beneficial to know about the different categories of common stock. Because depending on your financial situation, goals, and risk tolerance, one category may be more suitable than other. So with all the thousands of companies currently in business, a classification system has developed to categorize them.
Here are six basic categories that you should know about:
Blue Chip Stocks
Blue chip stocks are those of highly regarded, investment-quality companies.
The companies tend to be well-established, paying dividends both in years that it produces income and years that it produces losses. They’re also usually the leaders in their industries.
However, though blue chip companies are by definition high-quality, they may not always be good investments. The price for a blue chip stock may be so high that it makes for a bad investment.
Blue chip stocks include:
Defensive stocks stay relatively unaffected by fluctuations in the economy. These companies usually experience slow growth, lose popularity during prosperous economic times, and gain popularity during recessions.
However, most of these companies provide goods that are necessary for everyday life. As such, the demand for the goods won’t be as negatively affected by declining economic times.
Defensive stocks are found in the following industries:
Cyclical stocks tend to do move along with the overall stock market, doing well in prosperous economic times, and poorly during economic downturns. In recessions, these companies are faced with lower demand, leading to lower levels of profitability. Thus, they use cost-cutting measures to improve the bottom line and position themselves for the next economic upswing.
Cyclical stocks include those from the following industries:
Growth stocks are those of companies that have sales and earnings figures at higher rates than the general economy. Yet because these companies are growing, they usually don’t pay large dividends. Instead, most of the earnings are reinvested to support future growth. Stocks in this category are expected to appreciate faster than ordinary stocks.
For example, although Amgen doesn’t pay a dividend on its stock, it’s share price has risen substantially in the past twenty years.
Price appreciation is attractive to investors, because it remains untaxed until the stock is sold. This creates income tax deferral and allows for larger compounding returns.
Contrary to growth stocks, income stocks usually pay large dividends relative to other companies in the economy. These companies usually grow slowly, but continue to be profitable over time. Utilties are a good example of an income stock.
Value stocks are those with prices that are low relative to their historical earnings and current asset value. As such, they usually have low price/earnings ratios and may be out of favor in the stock market.
Value investors try to find these high quality companies that are temporarily undervalued, hoping that the market will recognize their true value, resulting in a price increase. One of the most famous value investors was Benjamin Graham, who is the man Warren Buffett credits a lot of his success to.
Photo by Katrina. Tuliao
Do you invest in individual stocks? Which types seem more attractive to you?