The Different Types Of Stocks Explained

Blue chip stocks are companies that are well established with a large market cap. These companies are reputable, and have a history of strong financial health and performance in their given sector. Examples include companies like Microsoft, Coca-Cola, Walmart, Nike and much more. Investors are often comfortable investing in blue chip stocks as these companies are household names.

Growth stocks are companies whose sales, earnings, and share of the market expand at a faster rate than the general economy and industry average. As the name implies, growth stocks tend to be focused on growth which requires aggression and investment into the company.

Due to this, growth stocks tend to pay little to no dividends to investors. The earnings that the company generates are instead reinvested back into the business. Growth stocks may allow an investor to receive above average price appreciation, but there are volatility risks to consider as growth stocks are willing to "take risks" to accomplish their goal.

Defensive stocks are companies who are recession resistant. Essentially, defensive stocks tend to perform well regardless of economic conditions. Defensive companies often sell products or services in sectors that are necessary such as utilities, consumer staples and essentials like food.

In other words, consumers will continue to buy products or services from these companies even during times of economic stress. When properly constructed in a portfolio, holding defensive stocks may benefit investors by protecting them from steep losses during a bear market (when the market is going down).

Cyclical stocks are companies whose performance typically follow the business and economic cycle. During times when the business or economic cycle is positive, cyclical stocks do well as consumers tend to have more discretionary income.

On the flipside, when economic or business conditions are poor, the performance of cyclical stocks retract and profits go down. Examples of cyclical stocks may include companies who sell household appliances and cars.

Dividend stocks are companies who consistently share a portion of their profits with investors by paying investors a dividend. Some investors choose to invest in dividend stocks for purposes of generating additional income, whereas other investors may choose to reinvest their dividends through DRIPs (dividend reinvestment programs).

Penny stocks are companies whose shares are valued at less than $5. Penny stocks are inherently risky and should be considered a highly speculative investment. Although some penny stocks trade on major exchanges, many of them trade through over the counter markets.

The companies behind penny stocks often have financial struggles and poor business metrics. Additionally, penny stocks are illiquid and are used by scammers promising ten fold returns as displayed in the famous Wolf of Wall Street movie which follows former stockbroker Jordan Belfourt's penny stock scam.

As the name implies, international stocks are companies who are based outside of your home country. For example,a US investor could diversify their portfolio by investing in reputable companies in other parts of the world such as Europe.

Investing in international stocks allows an investor to get access to different companies and economic cycles not available in their home country. When done properly, adding international stocks to a portfolio can allow an investor to reduce risk through greater diversification.

IPOs are companies that go public through a process called an initial public offering. This is the first time that a company will sell shares of its stock to the general public. Investors can buy these new shares on exchanges like the Nasdaq or New York Stock Exchange.

When a company goes public certain investors like to get in on the ground floor so to speak if they believe in the company. However, there are risks as well. Since a company is going public for the first time, investors may struggle to deduce if a company will perform well. Many professionals recommend only allocating a small percentage of a portfolio to IPOs.  

Beyond the categories described above, stocks are often distinguished by their market cap. A company's market cap is simply the value of the outstanding shares of the company. It is found by multiplying the value per share by the total number of shares.

For example, a company whose shares are trading at $100 with 100 million outstanding shares would have a market cap of $10 billion. Companies who have a market cap above $10 billion are large cap stocks. These companies tend to be well established and reputable due to their size which may reduce risk for investors.

Companies with a market cap of $2 to $10 billion are considered mid cap. These companies do not have as much stability as large cap companies, but often have greater growth potential as they can become large cap companies.

Companies with a market cap between $300 and $2 billion are considered small cap. These companies have the greatest potential for growth, but are also the riskiest of the three as they are less established and have less capital.

Beyond the categories of stocks described above, stocks can be further differentiated by class. Common stock is issued by all companies, but certain companies will also issue preferred stock as well. The differences can be found below.

As the name implies, common stock is the most common class of stock issued by public companies and is the first type that companies issue. Common stock allows investors the right to vote on important issues such as electing the board of directors, whether or not a stock may be split and more.

Voting can occur in one of two ways. With statutory voting, a shareholder gets one vote per share per voting issue. Under this method, the more shares held the more voting power held. The second type of voting is called cumulative voting.

Under this method, shareholders are able to multiply the number of shares they own by the number of voting issues. For example, say a company is holding an election for its board of directors. There are 3 seats available but 5 candidates.

Say a shareholder owned 100 shares. Under statutory voting, this investor would be able to cast 100 votes on three different candidates. Under cumulative voting, this investor would be able to cumulate their 300 votes and place them all on one candidate giving more power to smaller shareholders.

Common stockholders also have a right to receive dividends as an investor, but dividends are not guaranteed. Finally, if the company were to go under, common shareholders are last in line to be repaid. Creditors and preferred shareholders are entitled to be repaid first.

Preferred stock is often issued by established companies who already have outstanding common stock. Preferred stock is generally more suitable for investors who want income over capital appreciation. Unlike common stock, preferred stock does not typically offer any voting rights.

However, if a dividend is issued by a company preferred shareholders are guaranteed to receive the dividend before common shareholders. Additionally, preferred shareholders are entitled to be repaid before common shareholders if the company goes bankrupt or dissolves.

Beyond these differences, companies may add additional features to preferred stock to make them more marketable to specific investors. The first example of this is cumulative preferred stock. Say a company issued preferred stock with a 5% dividend based on a par value of $100 which would make the dividen $5

If this company were to fail to meet this dividend payout, the investor would be entitled to receive dividends in arrears. For example say that in Year 1, the company paid out a $2 dividend and in Year 2 the company paid out a $3.

The investor would be $5 short in dividends. If the company rebounded in Year 3 and had sufficient funds, the investor could receive $10 in dividends. This would include the $5 dividend for that year and the additional $5 of dividends in arrears not paid to the investor in the first two years.

If this investor owned non-cumulative preferred stock they would not be entitled to the dividends in arrears. Callable preferred stock allows the issuing company to buy back the shares from the investor at a specified price at some point in the future which is typically above par value.

Finally, corporations may issue convertible preferred stock which allows investors to convert their preferred shares into a predetermined number of common shares at a specified price. Convertible preferred stock often allows for greater price appreciation than standard preferred stock, but often pays a lower dividend rate.

Investing is a constant balancing act between risk and reward in order to accomplish a specific financial goal such as saving for retirement. One of the keys to accomplishing this successfully is to understand asset allocation.

Essentially, what mix and weight of investments will increase the likelihood of a desired financial outcome. This line of thinking can be applied to the various types of stocks. By understanding the various types of stocks, investors can construct a portfolio that best suits them.

For example, if an investor is young and is seeking a high level of return, they may decide to allocate a greater percentage of their portfolio to mid cap growth stocks if they can handle the inherent risk. If an investor is worried about an economic recession, they may decide to allocate a greater percentage of their portfolio to defensive stocks.

With that being said, investing in individual stocks is likely too risky or challenging for the average investor. However, investors can apply the same logic of knowing what and why they are invested in a particular type of stock through diversified investment funds such as mutual funds that may be composed of a variety of a specific stock type that an investor is after.

There are many different types of stocks that investors can use to build their portfolio including growth, defensive, cyclical, large cap, blue chip and more. Within these stock types, stocks can be further classified by their class (common or preferred). Understanding the various types of stocks can help investors better understand how to build a portfolio that is best suited for their individual needs.