An Overview to Different Types of Stock and How They Work

Overview to Different Types of Stock How They Work

Stocks are one of the essential parts of investing. So whether you’re looking to invest in individual stocks or mutual and exchange-traded funds (ETFs) that hold shares of different companies, here is some crucial information to note about the different types of stocks.

Common Stock

Investors are usually referring to common stock whenever they talk about stock. While there are different classes of stock, common stock is the standard one issued by all publicly traded companies.

Holding a common stock will grant you voting rights on who should be part of the board and other company matters during an annual meeting. Buying one share will generally give you one vote. So if you own, let’s say, six shares of the company, that would amount to six votes.

On the other hand, if a hedge fund holds about 30% of the company, that could be equivalent to millions of shares. Still, you can hold a non-voting common stock.

Regarding profit, there is no limit to how much a common stock can generate from price appreciation when the company performs well.

Some common stock can also pay dividends, although they are variable and not always certain. Moreover, common shareholders are usually last to receive payment in the event of bankruptcy.

Preferred Stock

Unlike common stocks, preferred stocks can’t grant you the right to vote. In fact, only several companies are able to issue them. That said, preferred stock offers a few benefits of owning a common stock and bond in one equity instrument.

For starters, preferred shareholders get paid guaranteed dividends. This may be higher than what a common stock offers, on top of the stock’s potential for price appreciation. Owning a preferred stock will also put you in line for payment if the company becomes insolvent, i.e., unable to pay its debts.

Additionally, the company can repurchase a preferred stock, provided it is callable. You can also convert your preferred stock to common stock if you want to.

Large-Cap Stocks

Stocks of public companies can also be grouped based on market capitalization or market cap, which represents the firm’s market value. The market cap can be determined by multiplying the total number of the company’s shares by its current stock price.

Large-cap or big-cap stocks usually refer to public firms with a market cap of $10 billion and higher. Investors choose these stocks for their stability. They are also less risky since large-cap firms are established and have an excellent history of surviving market challenges and volatility.

However, before investing in stocks from big-cap companies, one thing to consider is that they lack growth speed, making their potential returns not as high as the newer and smaller firms.

Mid-Cap Stocks

Mid-cap stocks are companies with a total market cap between $2 billion and $10 billion. They can be firms with the potential to grow big in the future, or they are the ones that formerly belonged in the large-cap category.

Mid-cap companies are financially stable like well-known companies, but they have the growth potential similar to smaller businesses. Mid-cap stocks present growth potential as they expand their markets share in their industry. They are also often the top choice for mergers or acquisitions by large-cap firms.

Small-Cap Stocks

Small-cap stocks represent companies with a market cap of around $300 million to $2 billion. This type of stock offers the most growth potential, but it is also the riskiest as it goes through increased market volatility.

Moreover, small-cap stocks can include firms facing bankruptcy and businesses perfect for acquisition. If you’re considering putting money into small-cap stocks, keep in mind that you will be investing in a stock with excellent profit potential. However, you will also be risking incurring huge losses.

Dividend Stocks

Dividend stocks are companies that pay their shareholders dividends on a regular basis. Such stocks are usually well-established firms with an excellent record of distributing a portion of their profits back to shareholders.

Dividend stocks can also have a tax advantage. Many dividends are qualified, meaning they are subject to fewer capital gains tax rates than the income tax rates on ordinary dividends.

Some dividend investors prefer to reinvest their dividends to purchase more shares instead of taking cash. That way, they have a passive form of increasing their profit.

A dividend reinvestment plan or DRIP is a program that allows you to reinvest your dividends automatically. As long as the company is performing well and you have a well-balanced portfolio, reinvesting your dividends is a better choice than cashing out.

Growth Stocks

Growth stocks are usually companies expected to increase their profits and revenues more rapidly than the overall market.

Investors holding growth stocks expect to observe solid price appreciation over time. However, these stocks have a pretty high volatility potential. This is because the issuing firms could be taking some serious risk to fuel their expansion.

Additionally, growth stocks don’t usually pay dividends as the companies typically reinvest any earnings they generate to expand at a much quicker rate. Growth companies can also be small businesses that are new to the market. Moreover, they can be firms looking to drive innovation and change in their industries.

Value Stocks

Value stocks are shares of companies that you can buy at a discount. Simply put, value stocks are companies that investors see as undervalued in the marketplace. They are stocks with prices lower than the stock prices of firms in the same industry.

Usually, value stocks are companies with a low P/E ratio. Stocks that appear good by such an investment analysis ratio may have had their prices reduced by more significant market events unrelated to particular businesses or industries.

Cyclical and Defensive Stocks

Cyclical stocks represent companies that follow the business cycle of an economy. So if the economy is bouncing back from a slowdown, prices of cyclical stocks go up. But if the economy is weakening, their prices go down, and sales shrink.

A few cyclical businesses rely on consumer discretionary spending. That includes retail, technology, dining, and travel companies.

On the other hand, defensive stocks are firms less affected by the different phases of the business cycle. So whether the overall market is performing well or poorly, investors can expect consistent dividends and steady earnings with defensive stocks.

Defensive stocks include utility companies, healthcare, and consumer staples. They fall under defensive investments since their revenue, and possibly their stock prices, remain stable during the economy’s ups and downs.

Some investors bet on cyclical stocks when they expect the economy to expand and invest in defensive stocks when the economy is likely to contract. However, this strategy, called sector rotation, can be risky. No investor can be 100% precise in predicting the economy’s near-term performance.

International Stocks

Investing in international stocks allows you to have a direct stake in growth outside your home country. Plus, they can diversify your portfolio further since they are affected by different market forces.

Owning international stocks can help you enter rapidly growing economies and let you access different risk-return patterns. Moreover, international stocks can protect you from the losing buying power of the US dollar, although their returns can be reduced when the greenback is climbing.

It would be best if you also considered the potential impact geopolitical turmoil can bring to international stocks.

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