Different Types Of Common Stocks With Definition And Example
Common Stocks are issued by all public companies to allow investors to invest in their company in exchange for ownership rights. There are different types of common stocks that are categorized based on their characteristics and features.
You will get to know about those features from our what is common stocks article. We suggest you read that article to know the common facts.
Our main theme of discussion in this article will be to explain the various common stock types and how they differ from each other.
After reading this, you should be able to make a decision on which type of stock to invest in.
We will categorize common stocks into two different categories. Firstly, we will explain the different types of common stocks based on their characteristics. Then categorize common stocks based on the market cap of the company.
Types Of Common Stock Based On Features
Common stocks are entitled to dividends. They are volatile in terms of its price movement and are risky as well. But all common stocks receive dividends and some of the common stocks are not volatile at all.
The different types of common stock based on their features are:
1. Blue-Chip Stocks:
The term blue chip means ‘of the highest quality’. Hence blue chip stocks mean stocks that are of the highest quality among all common stocks.
These stocks belong to companies that have been paying dividends to its stockholders for a long period, usually for more than 10 years.
There is no specific qualification for a company to be classified as a blue-chip organization, but generally, if they have been paying uninterrupted dividends for a long time, they are considered as a blue-chip company.
Other characteristics of the blue-chip company include very high market capitalization, usually in the billions. In the sector that they operate, they are considered as market leaders.
For example, in the tech industry, stocks of Google, Facebook, and Apple, etc. are considered as blue-chip stocks.
The dividend payment is not exactly a compulsory requirement for blue-chip stocks. But even then, these companies prefer paying dividends for many years to its shareholders.
The dividend amount increases in value every year depending on the growth rate and profits the company makes. Moreover, Blue-chip stocks are listed in the stock market indexes, such as the S&P 500 and Dow Jones Industrial Average.
As previously mentioned, there is no specific requirement to be a blue-chip organization, the average market cap of blue-chip companies’ stands at $95 billion.
2. Income Stocks:
Income stocks are the kind of stocks that pay high dividends to the shareholders. These stocks belong to companies’ that have usually reached the mature stages of its life cycle.
Although the dividend amount increases, it is not as drastic as blue-chip companies due to the mature nature of the company.
The company has peaked maturity and there is hardly any growth potential left. Therefore, income stocks pay higher dividends but they do not appreciate as much as blue-chip stocks.
If you are investor wondering if these stocks don’t grow a lot, the dividend must be a low amount. This is not the case as income stocks have a higher percentage of dividend yield compared to other stocks.
The volatility levels of these stocks are also on the lower end so it is preferred by investors that like high dividends with low risk. Example of companies that issue income stocks are: companies that provide public utilities such as gas, electricity, and water, etc.
3. Growth Stocks:
Growth Stocks are different in the sense that they do not pay dividends to its stockholders. As the name suggests, these are companies that grow at a rapid rate, faster than the median growth rate of the market.
The idea behind investing in growth stocks is to earn from capital gains. They buy the stock at a low price when the company is in its initial stage. As the company grows rapidly, its share price also increases.
As the company doesn’t pay dividends, it uses all its earnings to reinvest in the company and ensure its rapid growth.
The investors then sell the stock when its price reaches a satisfactory level. Growth stocks are risky when compared to income stocks.
There is no guarantee that the company will excel and grow. Investing in such companies will require investors to thoroughly research the company before taking the plunge.
If the company does not advance or progress, investors will lose their money as they have not received any dividends to offset their investment.
Examples of companies that issue growth stocks are Cisco during the ’90s when it grew exponentially.
4. Value Stocks:
Value stocks can be purchased at a value price, i.e. their stocks can be purchased at a lower price when compared to its dividends, earnings, price-to-earnings ratio, and price-to-book ratio.
In simple terms, there is a clear mismatch between the stock price and company performance. The low value can be attributed to the negative perception of the company in the investor’s eye.
The negative perception arises from any legal trouble the company is facing. It can also originate from poor earnings report which discourages investors from putting their money into these stocks.
To spot a value stock, compare its price with stock prices of similar companies belonging to the same industry.
Naturally, the risk level of these stocks is quite high. Due to the ill-reputation of the company, investing in these stocks may not always be rewarding.
However, if the company can turn things around, it might be bringing in good returns.
5. Cyclical Stocks:
The price of cyclical stocks is directly linked with the economic situation. The economy goes through 4 stages in its cycle: expansion, peak, recession, and recovery.
Cyclical stocks move in accordance with these cycles. That is, these stocks perform well during the expansion and peak cycle and poorly during the recession. Companies that issue these stocks include automobiles, furniture brands, hotels, chemical firms, etc.
These are items that you’d buy or upgrade when the economy booms and you would cut these out first during the bad phase of the economy.
The trick is to purchase cyclical stocks during the recession and sell them when the economy peaks. However, cyclical stocks may even go to zero during a long and hard recession session.
They are in contrast to defensive stocks which we will cover down below.
6. Defensive Stocks:
We mentioned above that cyclical stocks are in complete contrast with defensive stocks. What we mean is, defensive stocks don’t appreciate or depreciate due to economic changes.
These stocks provide a stable dividend payout regardless of the stock market conditions. The company that issues these stocks has products that are in constant demand throughout the year.
This includes daily consumer goods, basic utilities such as water, gas, electricity, etc. As the demand for these products is more or less the same throughout the year, the stock prices also remain stable.
Therefore, defensive stocks are a low risk-low reward in nature. Defensive stocks can be used to counter high-risk stocks such as value and cyclical stocks.
They diversify the portfolio as well as reduce the overall risk of the portfolio.
7. Speculative Stocks:
Speculative stocks, as the name suggests, are used for speculation as their current prices are low but due to unforeseen events in the future, it may rise high.
They are high-risk high-reward stocks that may bring in big profits or not result in a financial disaster. As there is no definite way of fundamentally analyzing the price movement, it all boils down to speculation.
Speculative stocks can be found mostly in the tech and energy sector. They can be start-up companies or even well-established blue-chip companies.
The best time to invest in speculative stocks is during the bull market phase. Investors who like to take big risks might be attracted to these stocks. They will either be rewarded with a large capital gain or loss.
8. Penny Stocks:
These stocks are named penny stocks because they are priced at less than a dollar per stock. These stocks are issued by small companies which perform poorly and they are considered the least quality stock in the market.
Penny stocks are generally traded over the OTC (Over The Counter) market. The rate of return with penny stock is high but at the same time, the risks of trading them are high as well. Along with OTC markets, some penny stocks are also traded on major stock exchanges.
Recently, the U.S S.E.C (the United States Security Exchange Commission) changed the minimum share price of penny stocks from $1 to $5. While not for all, some investors made millions from trading penny stocks. For small traders, it can serve as a convenient investment.
Types Of Common Stock Based On Market Capitalization
Market Capitalization is the market value of a company. It is calculated by dividing the number of outstanding shares of a company with the price of one stock.
Market cap is not a static measurement as it changes from time to time depending on the number of shares issued by the company and value of each stock.
In terms of market capitalization, common stocks can be divided into 3 categories:
1. Small-Cap Stocks:
These stocks are issued by companies that have a market cap of less than $1 billion.
These stocks have the potential to offer the highest returns as there is a high scope for growth. As such, they are also risky and volatile. So either these companies are the next big thing, or they go bankrupt and exit the business.
2. Medium Cap Stocks:
These stocks are issued by companies that have a market cap between $1billion and $5 billion.
Medium cap companies are relatively unknown to investors but still big enough to garner their attention.
3. Large Cap Stocks:
Companies having a market cap of more than $5 billion are considered large companies and their stocks are called large-cap stocks.
These companies are listed in the major indices such as the S&P 500, Dow Jones Industrial Index, etc. They are well known to both consumers and investors on a global scale. Examples include Intel, Amazon, Google, etc.
Conclusion
In this article, we have learned about the different types of common stock that exist in the stock market.
We have categorized common stocks based on features and market cap. Based on features, there are 8 types of common stocks: blue-chip, income, growth, value, cyclical, defensive, speculative, and penny stocks.
Each of these stocks is different in characteristics that separate it from one another. Knowing their features allows investors to know which type of stock to go for. Based on market cap, there are 3 types of common stock: small, medium, and large-cap stocks.
This differentiation is done based on market capitalization. Small-cap stocks are risky and have the potential for high profits and large-cap stocks are well known as they are blue-chip companies.
