Types of Stocks
Stocks Classified by Expectations, Size
Investors classify stocks using several different means. One measure is the expectation investors have when they invest in a stock; another is the more quantifiable measure of size.
Growth stocks grow and keep growing. When they stop growing they aren't growth stocks anymore and their share price is likely to drop dramatically unless the slowing is seen to be the natural process of a maturing company.
Growth investors focus on share price appreciation and are not concerned with dividends since few growth stocks pay any.
Investors choose growth stocks for their above-average growth rates and hope the stock price follows the growth. This is always a judgment call because growth in revenue doesn't always translate into growth in earnings.
In fact, some growth companies reinvest all their earnings back into the company to fund more growth. This is a good strategy if growth continues. When growth begins to slow because competition is catching up or the company has grown so big that huge growth isn't possible, growth investors may move on.
Income stocks represent mature, stable companies that pay consistent dividends. These companies often don't have much growth room but are steady income producers.
Dividends are cash payments (usually, but not always) to shareholders by companies.
Dividends are a distribution of profits to the owners. Companies that pay regular dividends are valued for that extra return they provide shareholders.
Utilities are considered income stocks because they aren't usually expanding and often pay attractive dividends.
Companies that have income stocks often issue a special type of stock, called preferred stock, that has limited rights but pays consistent dividends.
The only reason to own preferred stock is for the dividends.
The stock's price may not rise (or fall) nearly as fast or as far as the common stock. Income investors like preferred stock from solid companies for its dependability.
People who own income stocks should do so in a tax-qualified account, such as an IRA, so the income is not immediately taxed. However, many retired people use income stocks to help pay for retirement expenses.
Value stocks represent companies that have been incorrectly valued by the market. For some reason, the stock price is lower than it should be to accurately reflect the value of the company.
Maybe other companies in the same industry sector are having trouble and this company's stock is suffering guilt by association. Whatever the reason, value investors look for these types of stocks, betting that the market will someday realize the company's true value and the stock price will rise.
This is a true buy-and-hold strategy that may take some time to work out. However, if you have done your homework, the rewards can be excellent.
Small, Medium, and Large Cap Stocks
Market capitalization or market cap is simply a way of referring to the size of a company in a manner that allows you to compare companies in different industries.
Annual sales would not be a good way to compare companies since that has little to do with the value of the company. Market cap gives you the total market value of the company.
You compute market cap by multiplying the number of outstanding shares by the current stock price. For example, if a company had 100 million shares of common stock outstanding and a current stock price of $45 per share, its market cap would be $4.5 billion (100 million x $45).
You can find the market cap of any stock reported on dozens of Internet sites such as Yahoo! Finance.com. Simply enter a symbol and the market cap will be among the data reported.
Investors categorize companies under one of these labels - although there is not universal agreement on the exact cutoffs.
- Micro cap: $300 million and under
- Small cap: $1 billion and under
- Mid cap: $1 - $8 billion
- Large cap: $8 - $100 billion
- Mega cap: More than $100 billion
These rankings are completely arbitrary and other sources may use different numbers.
Size matters in the marketplace. Small companies are riskier than larger companies are. They have shorter lifespans unless they grow or merge with a larger company.
However, with risk comes the potential for reward. Small cap stocks can outperform all other size stocks under certain market conditions, so many investors carry a small portion of them in their portfolio.
Small companies that grow to be big companies (like Microsoft and Apple) can make early investors very wealthy, but most don't. Large companies can protect their market share and fend off competitors more easily.
They may not grow as rapidly, but they may also pay consistent dividends. You invest in small companies expecting rapid and large growth, while an investment in a large company is more secure and done with the expectation of reasonable growth and dividends.