Types of Stocks

What are the different types of stocks?

A company’s stock is all of its outstanding shares, each share representing an ownership stake. Both private and public companies issue stock. Stocks of publicly traded companies are categorized by a number of different aspects. Some distinctions are based on professional financial analysis, while others are based on the company itself. Common ways of categorizing stocks include size, sector and industry, geographic location and investment strategy.

How Stocks are Categorized by Ownership Status

One primary distinction is ownership status: Shares can be either common or preferred. Common stock is the most basic type of stock. This is what investors typically buy to share in a company’s profit, which comes in the form of dividends or potential capital gains from selling a stock. Owning common stock gives you voting rights and eligibility to receive dividends if the company pays them.

Preferred stock is a step higher in the ownership hierarchy of a company, below bonds but above common stock. Typically, preferred stock receives regular income through dividends and has a higher yield than common stock. Owners of preferred stock receive preferential treatment in the order of who gets paid dividends first but give up the right to vote.

This hierarchy also applies in cases of bankruptcy or liquidation. Owners of common-stock are the last to receive a settlement if any funds remain to be paid out to shareholders.

Common stock is more volatile than preferred stock. Preferred stock is a defensive investment; its share price does not tend to decrease in downturns to the extent of common stock, provided the dividend payment is secure. The cost of a defensive strategy is that when the market enters an upswing, preferred stock misses out on the gains common stock generates when sold.

Preferred stock trades based upon the value of a generally fixed dividend. It can normally be purchased back by the issuing company if its value gets too high.

Common stock is riskier than preferred stock in that nothing is guaranteed. Increases in share price, dividends and settlements in a bankruptcy situation aren’t certain. However, this risk, or volatility, is the basis of long-term gains when the market recognizes a stock’s potential.

How Stocks Are Categorized by Size

The size of public company is assessed by its their market capitalization. This is one of the key categorizations after ownership status. Understanding market cap is easy: It is the stock’s current share price multiplied by the number of outstanding shares.

In general, companies with a market cap more than $10 billion are large-cap stocks, those between $10 billion and $2 billion are mid-cap stocks and those under $2 billion are small-cap stocks. Sometimes small-cap stocks are further defined with the additional category of micro-caps, which are stocks with a market cap under $300 million. Some of the largest firms, such as Amazon.com Inc. (AMZN) and Microsoft Corp. (MSFT), have a market cap above $1 trillion. These so-called mega-cap firms trade with a valuation above $200 billion.

How Stocks are Categorized by Geographic Location

A stock is typically distinguished at a broad geographic level as domestic or international. Domestic stock is issued from an American company and traded on an American stock exchange. The simplest criterion for identifying a domestic or international stock is where the company is headquartered. However, this does not necessarily account for how much of a company’s business is located inside or outside of the U.S.

International companies can issue stock either directly on an American exchange or through American depositary receipts (ADRs) that are tied back to the share listing in the foreign company’s country. ADRs are usually sponsored so they can be listed and traded on an American stock exchange. This holds foreign companies to financial reporting standards set by the U.S. Securities and Exchange Commission (SEC). Otherwise, investors are on their own to understand the financial regulations of foreign countries and exchanges to garner portfolio exposure to international businesses.

How Stocks Are Categorized by Sector and Industry

When looking at specific segments of the economy, stocks are divided into sectors and industries. Sectors cover large general chunks of the economy; they are all recognizable once you know them. They include energy, financials, technology, health care and utilities.

Industries break sectors down into more specific business lines. Within the health care sector, industries include advanced medical equipment & technology and pharmaceuticals. Within the basic materials sector, industries include aluminum, gold and forest & wood products.

Not all sectors and industries see their business performance move in the same direction during economic cycles. Cyclicality refers to the correlation of a company’s profitability and its related stock price with the movement of the economy.

Cyclical stocks are also referred to as consumer cyclicals as a sector. Industries within the sector are tied to the overall performance of the economy and consumer’s sentiment. Examples of consumer cyclical industries are auto and truck manufacturers; hotels, motels and cruise lines; restaurants and bars; most retailers; and home furnishings.

When the economy is expected to expand or recover from a recession, share prices of cyclical stocks rise. When the economy is anticipated to contract, share prices of cyclical stocks fall as investors rotate into defensive stocks or growth stocks.

Stocks identified as defensive are also called non-cyclicals. The goods and services of non-cyclical stocks have what is referred to as “sticky” demand because consumers need the products these companies provide no matter what the condition of the economy. Examples include food manufacturers and processors, personal products manufacturers and utilities.

How Stocks Are Categorized by Quality

Growth stocks of high quality and stability in producing long-term earnings sometimes earn the designation of “blue chip.” Investors seek blue chips for their ability to weather periods of economic uncertainty, based on their typical dominance in a specific industry. Common examples are Apple Inc. (AAPL), McDonald’s Corp. (MCD), Walt Disney Co. (DIS), JPMorgan Chase & Co. (JPM) and Walmart Inc. (WMT).

Penny stocks are the opposite of blue chip stocks in many ways. Blue chips trade at high prices equal to how the market values their quality. Penny stocks trade at a share price lower than at least five dollars and are typically not exchange-listed. These companies are considered high risk due to the uncertainty of their business models and low volume of traded shares. Uncertainty also stems from status as unlisted on public exchanges that require current and audited financial statements.

How Stocks Are Categorized by Investment Strategy

Financial analysis also plays a role in categorizing stocks, often to fit types of investment strategies. A prominent categorial dichotomy in this vein is growth stocks and value stocks.

Investors expect certain stocks to continue to grow their earnings and are willing to pay a premium today for that growth tomorrow. What’s necessary for a growth stock is a feature of new or expanding business. Growth investors don’t mind buying high because they expect to sell at an even higher price.

Age of a company or the age its sector and industry is not necessarily a determining factor of growth. Older companies achieve growth through new technology, strategy shifts, new markets for products or acquisitions. Young growth companies are usually involved in rapidly expanding industries that receive a lot of media and investor attention, such as the online services industry of the technology sector.

However, the attention paid to highly salient growth companies often makes it hard to buy their stock at an undervaluation as desired by value investors. The market has priced in expectation with lots of information.

At the center of a value investing strategy is the idea of buying low and selling high. Value investors look for stocks that they perceive the market has missed as an opportunity for growth, mispricing the value of a company. The market misses opportunities because it is constantly changing and is composed of investors whose decisions are subject to their emotions.

A potential downside to a contrarian approach to selecting stocks is that the market often has appropriately priced a stock; its low valuation is born out with a lack of eventual growth.

Some investors look for income from stock as a specific strategy. This means looking for companies that offer dividend payments to their shareholders, which not every company does.

Growth companies are generally not expected to pay a meaningful dividend. Management is using profits to continue to generate new business; the growth of the company attracts new investors. On the other hand, value companies are more expected to offer dividends to shareholders, as they tend to be more mature companies. The distinction mainly relies on growth stocks lacking a meaningful dividend.

What Are Share Classes?

There is one slightly different distinction for categorizing stocks compared to what has been discussed thus far. A stock might have different common share classes, often designated by letters of the alphabet. The designation may come with differing share prices and dividend policies; the most important is voting rights.

Companies with multiple share classes usually only offer one class on public exchanges. Non-traded shares are more likely reserved for company founders and management, granting stronger voting powers and control of the company.

If you invest in the stock of a company where insiders control voting power, your common shareholder interests may not be represented. It becomes difficult to determine if the company is making the best decisions for everyone with a collective interest in the company’s direction.

Sometimes companies have different share classes following the acquisition of a prominent firm. In the 1980s, General Motors Co. (GM) issued Class E stock for its acquisition of Electronic Data Systems and Class H stock for its acquisition of Hughes Aircraft. At the time, this was rather innovative.

Google is a contemporary example of a multi-class share structure. This was initiated when the company became Alphabet Inc. Class A shares under the ticker GOOGL and Class C shares under the ticker GOOG trade at similar prices, but the latter share class has no voting rights. Class B shares are reserved for insiders.

How Do I Select the Right Type of Stock to Invest In?

The right stock type to invest in is based on your goals for return and your tolerance for risk. Stocks are categorized by a wide set of definitions, which helps investors to better analyze a potential investment. As with any investment product, any stock should be compared peer-to-peer. Different types of stocks can have unique attributes that lead to different performance depending on the market.

Variation in expected return from an investment is the risk you take on as an investor. Opportunities for return are smaller without risk. As an investor, remember that higher long-term returns are associated with higher risk.

There are really two aspects of this risk: inherent market risk and company risk. The former stems from movements in the overall market; the latter stems from changes in a company or its industry, or the way investors perceive the company or its industry.

Market risk cannot be utterly avoided because all stocks are affected by the entire market to an extent. However, it makes up much less of the actual risk investors face when choosing a stock. Individual company risk accounts for most of the total risk investors face. The key difference between the two aspects of risk in this case is that individual company risk can be almost eliminated by portfolio diversification.

Cognizance of the different stock types enable you to build a diversified portfolio, which will allow you to take on more risk intelligently. Investors are also awarded an equity risk premium for holding stocks.

If you do not want to build a portfolio of individual stocks, mutual funds and exchange-traded funds (ETFs) are solutions. Professionally managed funds set targets based on a specific investment strategy. This includes diversification, depending on the objective of the fund. There are lots of equity-based funds to choose from.

Conclusion

There are many ways of categorizing stocks. At first, the information can be overwhelming. However, once you begin to absorb the information and turn it into knowledge, understanding how to categorize stocks will aid you in becoming a smarter, more confident manager of your investment portfolio.

Common ways of categorizing stocks include size, sector and industry, geographic location, quality and investment strategy. Ownership status and share classes also offer different voting rights. Some categories are determined by financial analysts and others are determined by the company itself. All of this happens in the context of the market.

Stocks do not all move together in the market, though they are subject to the overall market sentiment. Different companies perform well in different economic cycles. Investors move their money in reciprocation.

Ultimately, your investment goals will determine the right stock type for your portfolio. This is based on your appetite for return and your tolerance for risk. Diversification is the key to building a portfolio, and stock types qualify diversity.