Common stocks represent ownership in a company. For example, if you are holding 10 shares of company A out of total 100 outstanding shares,then you are 10% owner of the company A.
When a new company is formed, common stocks are subscribed to the shareholders or owners to raise money. At a later point of time, if the company has decided to raise more funds through equity, then they can do so by issuing common stock in exchange for money.
A company can get listed with any stock exchange to allow its stock to trade. In such a case, the public based on the rules and regulations, can participate to be an owner of the company by buying some of it’s stock through stock exchanges.
Depending on the strategy, companies can also issue bonds to raise funds.
What is common stocks?
We have already discussed what is common stocks. In this article, we will be discussing different types of common stock that is categorised based on certain parameters and investment styles.
Remember, all common stocks represent ownership interest on companies. These shareholders can vote on important issues based on their percentage of holding.
They also have a right to share in the company’s net earnings. When board of directors decide to pay out a portion of a company’s earnings in dividends, all common shareholders have a right to receive them in proportion to their holdings. If the board of directors decide not to declare a dividend, then none of the shareholders will get a dividend.
Now, let’s discuss different types of common stock.
Common stocks are classified into different categories based on certain factors.
Classification is important because you will be able to know the return, quality of the stock, market stability and the relationship of risk affecting the company and market.
Companies which have a long history of paying dividends are considered as blue-chip stocks. These companies are well established with a proven track record of performance over the years. They maintain leadership positions in their respective industries.
Here are the most important characteristics of blue-chip stocks;
- Maintain leadership position in their respective industries
- Large in size
- Long history of stable earning and dividends
- Dividend payout increases to meet or beat the rate of inflation
- Strong balance sheet
Investors buy blue-chip stocks to get a regular dividend in addition to capital appreciation.
We have companies which pay regular dividends higher than the average dividends paid by the market. These companies are considered as income stocks.
These companies pay a major portion of their earnings as dividend because they are more mature in their respective industry and require less than the money they generate to fund expansion.
Shares of Blue-chip companies are also considered as income stocks based on how much dividend they pay.
Here are the most important characteristics of income stocks;
- Dividend aristocrat – record of paying higher dividend that the others in market
- Higher payout ratio – Pay out a much higher ratio of net profit as dividends.
- Strong balance sheet
- Stable earnings
- Large in size
- Higher dividend yield
Certain small and mid-cap companies generally grow in sales and earnings at a higher rate over a period of time in comparison to others in the industry. These companies are known as growth stocks.
Here are the most important characteristics of growth stocks;
- Growth in sales and earnings is high compared to others in the same industry.
- Payout ratio is less or pays no dividend. Which means almost all earnings are reinvested into the company.
- Small in market size.
- Doesn’t have a leadership position in the industry. But due to the growth, it can have a leadership position.
- Company is part of a growing industry.
Investors buy these stocks for their capital appreciation.
Certain companies can be out of flavor for the investors due to disappointing results for a year or two or due to some other reasons.
As demand for these stocks are low and supply is high, share price falls below their original intrinsic value. Due to which, these stocks started trading at lower P/E ratios.
Here are the most important characteristics of a value stock;
- Low P/E ratios
- Have track record of good profit but due to temporary set back its trading at a low price
- Fundamentals are good
- Strong balance sheet to grow
- Higher intrinsic value but lower market price
Value investors with a long term mindset, buy these types of fundamentally strong companies which have all the potential for growth. Stocks of these companies are referred to as value stock.
When a company’s intrinsic value is higher than its market price, the stock may be undervalued. The stock will be overvalued when intrinsic value is below the share price.
Perhaps the most famous value investor of all time is Warren Buffet. You can learn about his investing style to be a successful value investor.
Stocks are categories based on the sectors in which they are working. It’s not based on the income they share with the shareholders or capital appreciation in comparison to market. It’s purely categorised based on their market presence. Here are the two most important category;
Certain companies grow with the state of the economy. Due to which, their share price moves according to the economy.
These stocks perform poorly when the economy is in recession and do well during the period of expansion. For example auto industries, infrastructure and capital goods.
Certain companies are into defensive sectors such as food and beverages, public utility, drug companies and consumer goods.
These sectors are expected to remain stable when the overall economy is declining.
Due to which share price of these companies are expected to remain stable or do well when the overall economy is declining.
Speculative stocks are shares of those companies whose market price is more volatile than the market.
These companies do not have a great track record of earnings and sales but you can see large increases in price.
Penny stocks, those companies which have a low market price, are falling into the category of speculative.
Large-cap, mid-cap and small-cap
Based on the market capitalization, stocks can be categorised to small-cap, mid-cap and large-cap.
Market capitalization is calculated by multiplying the company’s stock price with the number of shares outstanding.
We have written a different article explaining how stocks are classified into large-cap, mid-cap and small-caps. You can refer to that article.
Which type of stocks do you think are the best for you to maximize your wealth over the long-term? Share your comments with us.