Types of Stock Investors Should Know
Almost everyone has heard of stock, and you likely know what the Securities and Exchange Commission (SEC) is and does. However, you may not know there are multiple different types of stock out there. These categories help investors put together their portfolios by choosing the kinds of investments that are appropriate for them.
If you’re investing, it may be useful to know and understand the different types of available stock. This is a resource page for you to reference so that you can understand the differences.
Different Types of Stock – Common vs. Preferred
Common stock is, as the name suggests, the most common type of stock available to investors. With the purchase of common stock, you get a share in the ownership of the corporation along with voting rights. While this type of stock sometimes comes with dividends, dividend payments aren’t guaranteed.
In the case of poor company performance or bankruptcy, common shareholders are last in line to receive a share in company assets. This makes common stock riskier than bonds and preferred stock. Also, common stock can be volatile because the stock represents the company’s performance. But common stock is usually better for long-term returns and growth than other types of investments.
The main difference between common and preferred stock is voting rights: Preferred stock doesn’t come with votes. However, there are some advantages to investing in preferred stock.
For one, it usually comes with fixed dividends. In the case of a company’s failure to pay dividends, preferred stockholders are toward the front of the line, before common stockholders, in collecting monies owed. Therefore, if a company declares bankruptcy, preferred stockholders are more likely to recover at least part of their investment than common stockholders.
Compared with common stock, preferred stock offers a lower potential for long-term growth. As a result, investors who are more interested in income rather than growth lean toward preferred stock.
Classes of Stock
Common stock can have more than one class. The most common classes are Class A and Class B, but companies can theoretically have as many classes as they’d like. Classes of stock are usually created to concentrate voting power to certain people or a group, such as founders of the company. This means Class A stock typically holds more votes than Class B stock. The most popular example of this is Berkshire Hathaway.
Currently, Berkshire Hathaway’s Class A stock goes for around $326,000. Its Class B stock is about $217. According to Warren Buffett, one share of Class B stock has 1/1,500th the rights of one share of Class A. However, each share of Class B has 1/10,000th of the voting rights Class A has. That is a large difference in both pricing and voting rights. Another advantage of Berkshire Hathaway’s Class A stock is its option of being convertible to Class B stock at any time.
Other Types of Stock
Growth stocks are expected to grow at a significant rate above the market average. Companies with growth stocks usually don’t pay dividends. Instead, they reinvest the money for short-term growth acceleration. Often these are innovative companies with unique products, patents, and/or access to advanced and rare technology. As a result, many tech stocks are growth plays rather than dividend earners.
Growth stock can be incredibly risky. Since there are no dividends, investors rely on selling the stock at a higher price than they paid to make a profit. If the company is successful, stock values will increase and the investor can sell for a gain. On the other hand, if the company fails, the investor will suffer a loss.
Value stocks are so-called because they usually sell for a low price compared with their fundamentals. In other words, the stock price may not be an accurate representation of the company’s actual performance. Some common traits of value stocks are high dividend yields, a low price-to-book ratio and a low price-to-earnings ratio.
The equity price is often lower than the industry average, and the company may be viewed unfavorably by the market. This makes value stocks risky because in order to make a profit, the market must change its view on the company. But compared with growth stocks, value stocks tend to have a higher long-term return.
Blue Chip Stocks
Blue chip stocks are shares of large, well-established and financially stable companies. They have reliable earnings and are often either market leaders in their industry or are household name brands. Examples of blue chip stocks include Microsoft, Google and Apple.
Blue chip stocks are the most stable type of stocks when it comes to paying dividends. Since many investors tend to believe blue chip stocks can survive any market challenges, they tend to be the most popular stocks. However, their success isn’t guaranteed – the recent bankruptcy of Sears is a prime example of how a long-time blue chip can go south – and it’s always advised to practice portfolio diversification to decrease risk.
According to the SEC’s definition, a penny stock is a stock that trades under $5 per share. Originally, it referred to a stock trading cheaper than $1, but the SEC adjusted its definition for inflation.
Most penny stocks are traded over the counter through the OTC Bulletin Board (OTCBB). Usually these are small and growing companies with limited resources. Penny stocks tend to lack liquidity or ready buyers. This makes them difficult to sell because there may not be any ready buyers or a price that accurately represents the market. Investors with high risk tolerance may be more likely than their peers to invest in penny stocks due to the investment’s high volatility.
Income stocks are usually shares of well-established companies that consistently provide dividends. Usually these dividends steadily increase to compensate for inflation and provide higher-than-average income. This is because the company has more financial incentive to pay out dividends than to reinvest the money in new projects or products. Income stocks are less volatile and are, therefore, considered less risky.
A speculative stock can be thought of as a stock with unrealized potential. Usually these are emerging market stocks from new companies or those in a risky sector, such as biotechnology. They tend to be low in cost but have high risk. The company may not survive, which happens often in many innovative fields.
Speculative stocks are typically picked up by traders with high risk tolerance. This type of stock has high volatility with the possibility of a great outcome. Investors must speculate as to whether or not the company and stock will successfully perform. Unfortunately, an investor lacking diversification would likely have difficulty managing their losses if the company fails.
Cyclical stocks are named after the economic cycle. They are sensitive to economic trends and are affected by macroeconomic changes and shifts. Although cyclical stocks have relatively high volatility, they tend to generate high returns in periods of economic success.
These stocks have great potential for growth and a tendency to outperform the market. Usually these companies produce discretionary consumer items and services such as homes, cars and travel (i.e., airlines). These are things people generally will not purchase or use during a period of economic recession. If the recession is bad enough, the stock can become worthless, and the companies can go under.
In a market downturn or recession, defensive stocks are a good safety net. This kind of investment is generally in the consumer staples sector. These companies are often selling items such as food and gas that people will consistently need and spend money on, even when money is tight. Defensive stocks will often provide constant and stable earnings. However, they may not be the best investment for investors looking to make a profit in an average market.
Final Thoughts on Types of Stock
Now that you have a better understanding of the different types of available stock, you can make more informed decisions about which investments are right for you. For more investment information, sign up for our free e-letter below. It’s packed with useful insight and tips for wise investors like you.