Investing in Stocks: Stock Types, Market Capitalization, and Market Sectors
Investing in stocks means buying shares of ownership in a public company with the goal yielding higher returns when compared to alternatives such as certificates of deposit, gold, and treasury bonds. The average stock market return has been about 10% annually since 1926.
Depending on the overall performance of a company, its share price can rise or fall throughout the day. Stock share prices can range from a few pennies to hundreds of thousands of dollars. Because of this inherent volatility, investing heavily in stocks is generally recommended for investors with the risk capacity to stomach the lows and willing to stick with stocks over long periods of time.
Before you start investing, make sure you have a manageable budget, an emergency fund, and little to no high-interest debt.
The major types of stocks you should be familiar with are common stock, preferred stock, large-cap stocks, mid-cap stocks, small-cap stocks, domestic stock, international stocks, growth stocks, value stocks, IPO stocks, cyclical stocks, non-cyclical stocks, ESG stocks, blue chip stocks, and penny stocks.
- Investors who buy common stock not only own a small piece of the company, they also share in its profits and usually have voting rights. If a company files for bankruptcy, common shareholders are last in line to claim residual assets. Often, a company will offer only common stock.
- A preferred stock grants some enhanced characteristics or benefits. If a company can't afford to pay preferred shareholders a dividend, then common shareholders won't receive one. Similar to bonds, preferred shares usually pay dividends, but they usually don't come with voting rights.
- A growth stock is one that's expected to grow much faster than the market's average growth rate. Companies that are considered "growth companies" are in the earlier stages of their business cycle and expected to grow their revenue faster than the market average.
- The opposite of a growth stock is a value stock, which are generally companies at a later stage of their growth cycle and typically trade at lower price-to-earnings (P/E). The P/E ratio is equal to the share price divided by earnings per share. Outside of looking at individual stocks as a primary means of investing, you can also invest in a value-related exchange-traded fund (ETF), index fund, or other value funds like hedge funds that take a value investing approach.
- International stocks differ from domestic stocks in that the company's official headquarter is located outside your home country.
- Stocks are also categorized by the total worth of all their shares, which is called market capitalization. There's no precise line that separates these categories from each other. Small-cap stocks are generally those with a market capitalization of $300 million to $2 billion. They often outperform large-cap stocks, on average, but have more volatile share prices. Large-cap stocks have a market cap of at least $10 billion, while mid-cap stocks are those with market caps of $2 billion to $10 billion.
- Penny stocks are generally nano-cap stocks trading for less than $5 a share and come with substantial risks compared to ordinary stocks.
- Cyclical stocks, to some degree, are usually concentrated within certain sectors/industries whose products and services are more immune to economic downturns. They include restaurants and hotels, automakers, construction companies and typically outperform during times of economic expansion, but underperform when the economy displays weakness, or when investors are anticipating economic weakness. Non-cyclical businesses are less exposed to the economic cycle and typically outperform during times of economic contraction.
- A blue-chip stock is a share of a large, successful company with a high market cap and a great reputation. The phrase "blue chip" is a reference to poker, in which the blue chip is worth the most money.
- IPO stocks are stocks of companies that have recently gone public through an initial public offering (IPO). A stock generally retains its status as an IPO stock for at least a year and for as long as two to four years after it becomes public.
- Environmental, social, and governance (ESG) investing refers to an investment philosophy that puts emphasis on environmental, social, and governance concerns.
Investing across companies of different market capitalizations, geographies, and investing styles contributes to a well-balanced portfolio.