To add to the previous informative post on Order Types, I’ll be posting a series of additional informational articles on different investment “vehicles” (i.e. types of investments). Over the next couple of my posts, I’ll be looking to cover the various types of stocks, bonds, mutual/hedge funds, Index/Exchange-Traded funds, & Real Estate Investment Trusts/Private Equity investments along with various ways of breaking each down to into further categories for a deeper level of classification. As the title illustrates, this post will highlight the 2 main types of stocks, the pros and cons of each, along with further classification characteristics of stocks in general. Similar to the previous post on Order Types, the following information is intended to be strictly informational & educational rather than serve as advisement on your personal portfolio.
Stock Types
Common Stock – Highest relative risk, Highest relative reward potential, generally speaking.
- Majority of stock out there is considered Common Stock. When a retail investor places an order through a broker to buy stock shares, this is the type of stock they are purchasing, in most cases.
- Common Stock represents a portion of ownership in the company the stock relates to & so subsequently, it gives the owner of the stock a claim to a portion of the company’s net (after-tax) profits relative to the amount of shares they own.
- Pros
- Typically exclusive to Common Stock, it gives the shareholder rights to vote in the election of board-members.
- Generally, has potential to receive a dividend that varies relative to how the company performs & also increases in market price more than Preferred Stock when the company does well.
- Con
- In the case of a company bankruptcy, Common Stock shareholders are usually paid last if there is any money left in the business after paying out all of the parties that are paid before Common Stock shareholders.
- Typically, Common Stock shares decrease in market price (i.e. value) more than Preferred Shares when a company does poorly.
- A diversified portfolio in companies with a long-standing history of financial strength and strong earnings is the atypical strategy that’s preached by many financial adviser’s to reduce both of the risk aspects related to bankruptcy scenarios & the value of the stock going down.
- In theory, that diversified portfolio could give you exposure to the upside when the companies in your portfolio do well while limiting the downside of a decreased value when they do poorly.
Preferred Stock – Less relative risk, Lower relative reward potential, generally speaking.
- Pros
- The vast majority of Preferred Stock shares come with a guaranteed fixed (i.e. does not change in amount) dividend payment annually. (beneficial to income-focused portfolios)
- In a company bankruptcy scenario, Preferred Stock shareholders are paid before Common Stock shareholders.
- Cons
- In most cases, not as rewarding as Common Stock when it comes to market price (i.e. value) growth. However, on the flip side, Preferred Stock generally decreases less in price when the company under-performs, making it a ‘safer’ investment than Common Stock.
- Similar to Common Stock, Preferred Stock represents a portion of ownership in the company the shares relate to, but does not come with voting rights.
Classification of Stocks
Companies typically follow a strategy to categorize and compensate their shareholders. The main 3 types of stock classifications that correlate to companies stock strategies are; Income stocks, Value stocks, and Growth stocks.
Income Stocks: Have potential to provide income for the shareholder.
- In most cases, the companies w/ stock considered Income stock have a history of consistently paying a quarterly dividend to shareholders of the company’s stock.
- Beneficial to retirees that are seeking a steady income stream thanks to the dividend payments each quarter.
- On a deeper level, dividends combined with the stock price increasing has potential to provide more money to the shareholder than bonds and other ‘fixed income’ investments that coincide with the income stream strategy many retirees are looking for in investments. However, there is the risk that the stock depreciates if the market falls.
- Generally related to high-quality, well-established companies with historically strong profits & steady dividend increases.
- Examples: Energy & Utility Companies.
Value Stocks: Labeled ‘value’ due to being considered “under-priced” when compared to similar company’s stock.
- Characterized by any or all three of the following: Low Price-to-Earnings Ratio, Low Price-To-Book Ratio & Low Price-To-Dividend Ratio.
- A note of caution, the considered value could be due to various factors such as financial trouble for the company, upper management problems within the company, poor investor sentiment or cyclical trends that are causing the company performance troubles.
- It’s very important for an investor to analyze factors that may attribute to the considered ‘value’ status of the stock and conclude if the investor believes those factors can turn around.
- In concept, with Value stocks, the investor is betting on the rebound of the stock to go from it’s current value to a value similar to that of comparable companies’ stock.
- A conclusive interesting note; stocks considered Value stocks have outperformed ‘Growth’ stocks over the last century.
Growth Stocks: Related to the company being in the ‘Growth’ business cycle, where their profits are increasing quickly.
- The increase in the company”s profits subsequently influences an increase in the company’s stock price, in most cases.
- ‘Growth’ stock companies generally reinvest their profits and pay small or no dividends.
- Therefor, the hope of companies following a ‘growth’ strategy with their stock is that the appreciation of the stock’s price will keep investors content.
- Typically tech-focused companies over the past 10 years.
- In times of rapid growth, the stock price increase due to increasing profits can get hyped up by investors and subsequently overbought, causing a relatively high Price-to-Earnings Ratio. If over-hyped enough, this scenario could lead to a sell-off as investors attempt to lock in profits they’ve made.
Size Classifications
Market Cap: Quantifies the size of a company based on the current price of it’s stock multiplied by the number of shares the company currently has outstanding (i.e. held by shareholders).
Companies can be categorized in accordance to their level of market cap. Additionally, based on historical standards, there is a STRONG correlation between company’s market cap size & the risk of investment in that company.
The breakdown of market cap levels is debated across the investment industry, but the following is generally how I prefer to breakdown the varying levels of market cap.
- Mega-Cap: Greater than $100Billion
- Large-Cap: $25Billion to $100Billion
- Mid-Cap: $1Billion to $25Billion
- Small-Cap: $250Million to $1Billion
- Micro-Cap: $50Million to $250Million
- Nano-Cap: Less than $50Million
‘Small-Cap’ companies are generally more risky than ‘Large-Cap’ companies because they’re typically less established, weaker positioned in the marketplace, have less resources available to deal with problems that arise, and there is less historical data on how the company is affected by economic cycles.
However, an interesting note; due to the higher risks, smaller-cap companies have outperformed larger-cap companies over the past century, generally speaking.
As always, I hope this information benefits any of readers out there & if there is any questions regarding the material above, feel free to comment below & I’ll get back to you as soon as possible.
I’ll look to follow this post up shortly with the concept of Bonds, highlighting the various types, the pros & cons of Bonds in general and the various ways the market classifies the multitude of bond types out there.
Until next time,
Zach Veencamp