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Understanding the Different Types of Stocks

Understanding the Different Types of Stocks

Understanding the Different Types of Stocks

2.1 What are the different types of stocks available to trade?

The New York Stock Exchange – the largest stock exchange in the world – has approximately over 2,500 companies listed on its mainboard [1,2].

This factoid handily illustrates the sheer number of choices confronting an investor stepping into the stock market for the first time. With so many different stocks and shares available, how do investors choose which stock to trade?

Well, to choose stocks in a more strategic manner, it may be helpful to sort stocks into groupings based on certain characteristics or features.

Conventionally, stocks are categorised by region, or sector and industry. Additionally, stocks may also be arranged according to groupings such as blue-chip stocks, market capitalisation level, growth potential, and whether or not they offer dividends. Stocks can also be categorised based on their value relative to their share price.

If these groupings seem a little discordant, that’s because they aren’t standard or official definitions. Rather, these are just some categories that came to the forefront of the popular consciousness over time.

How does an investor choose stocks?

Ultimately, it comes down to a mix of personal preferences and investing goals.

Let’s talk about personal preferences first. Some of the investors may avoid investing in oil companies as a way to support the push for eco-consciousness. Others may choose not to invest in tobacco and alcohol manufacturers due to religious affiliations. This would mean filtering out stocks of these categories, and focusing on companies that are aligned with their own values and beliefs.

Secondly, the goals and objectives that investors have for their investments can also impact the selection of stocks they choose. For instance, young investors looking to grow their portfolio may be focused on small-cap, high-growth stocks. They are willing to take on more risk and volatility, as they have a longer timeline to absorb shocks.

Conversely, an older investor nearing retirement may be focused on preserving his capital and generating passive income. Hence, he is more likely to choose stable, mature companies with a proven record of consistent dividends, and is less focused on growing his portfolio.

2.2 Large-cap, mid-cap and small-cap stocks

One of the more popular ways of categorising a stock is by market capitalisation – which you may recall from Module 1 is a measure of how large a listed company is.

To recap: Market capitalisation, or market cap, is derived by multiplying the share price by the number of outstanding shares held by investors.

We can group stocks according to three categories – large-cap, mid-cap and small-cap, as follows [3]:

  • Large-cap stocks: Market cap of USD 10 billion or more
  • Mid-cap stocks: Market cap of USD 2 billion to USD 10 billion
  • Small-cap stocks: Market cap of USD 300 million to USD 2 billion

Along with the differences in market capitalisation, large-, mid- and small-cap stocks are also likely to display certain characteristics. See the following table for a summary [4].

Market capitalisationRisk vs ReturnsProfile
Small-capHigher risk, less stable, more susceptible to economic shifts.
Potential for rapid growth and high returns.
Niche players, emerging startups.
Mid-capModerate risk, more stable, less sensitive to economic changes.
Offers balance between growth potential and stability.
Established companies with regional or global presence.
Large-capLeast risky, highest resilience to economic shocks
Steady and stable returns, especially over the long run, but limited room for explosive growth
Well-known market leading companies, household brand names.

2.3 Blue-chip stocks

Blue-chip stocks symbolise the top-tier category within the realm of company stocks. They are usually reserved for stocks with a long and established history of spectacular growth and strong performance in all market conditions.

Some popular blue-chip stocks today are Apple (APPL), Microsoft (MSFT), Amazon (AMZN) and McDonalds (MCD), Johnsons and Johnsons (JNJ), Coca-Cola (KO) and ExxonMobil (XOM).

As you can see, blue-chip stocks may be found in any sector or industry, and are good choices to go with when exploring stocks in sectors you may be unfamiliar with.

However, note that blue-chip stocks are not homogeneous. For instance, KO is a known dividend income provider, but offers little growth potential. Meanwhile, AMZN has achieved spectacular levels of growth.

Incidentally, the term “blue chip” refers to chips of the highest value used in poker games.

Because of their proven track record, blue-chip stocks often form the core of an investment portfolio. However, blue-chip stocks can also be costly, requiring a large capital to invest.

2.4 Growth stocks

Growth stocks are stocks of companies that are expected to grow at a faster rate than the industry or sector average. Typically, these are relatively young companies that may not be profitable yet.

However, the majority have consistently achieved revenue growth at a substantially higher rate than their competitors, allowing them to command higher share prices that translate to capital gains for shareholders.

Therein lies the allure. Growth stock investors are willing to pay a higher share price in expectation of the stock outperforming the market in future. However, if circumstances deviate from the anticipated trajectory, growth stocks may experience rapid declines in value, especially if investor confidence takes a hit.

Here are five characteristics that mark a growth stock [5,6].

  • Rising profit margins or narrowing profitability gap with strong sales growth
  • Unique or innovative market position or product offering
  • High returns on equity (ROE), which indicates greater efficiency in using capital to generate revenue
  • Manageable levels of debt. The company’s liabilities should be roughly in line with those of competitors, so as to avoid over-reliance on debt for growth
  • Does not usually provide dividends

Given the above, it is not surprising that growth stocks are usually small-cap companies.

However, some larger companies may also be growth stocks. Consider Netflix and Tesla, which are two of the world’s biggest tech companies. Despite this, their stocks are highly sought after by growth investors, as evidenced by their high P/E ratios. (See Module 5)

2.5 Overvalued and undervalued stocks

The price of a stock may be considered too high or too low, relative to its perceived growth potential.

When a stock is described as “overvalued”, what it means is that its price is too high for the earnings the company is generating or expected to generate. Investors should consider holding off on purchasing a stock while it is regarded as overvalued. 

Conversely, a stock that is “undervalued” has a price that does not accurately represent its inherent value, due to lack of interest or awareness among investors. Undervalued stocks make for great picks for those pursuing a value investing strategy.

The terms “overvalued” and “undervalued” are not fixed, and a stock can move between both over time. Also, these terms are somewhat subjective, as different analysts may use different metrics when evaluating a stock, or have differing expectations of a company.

2.6 Dividend stocks

Dividend stocks distribute part of the company’s profits to shareholders. Once declared, dividends are distributed to investors in proportion to the number of shares they hold.

For instance, if a dividend of USD 0.20 per share was declared, an investor holding 3,000 shares will receive USD 600. Dividends may be cashed out, or reinvested by purchasing more shares.

Companies commonly pay out dividends at fixed intervals, such as quarterly or half-yearly. However, some companies may only declare dividends on a semi-regular basis, and even regular dividend-paying stocks may decide to lower or pause dividends during difficult periods. Dividend stocks are usually sought after by investors seeking to build an income stream. Adding dividend stocks with an established track record of regular payouts that increase over time is likely to help investors to build passive income that grows as they invest.

2.7 International stocks

U.S. stocks

Many of the largest companies in the world are of American origin, making U.S. stocks a popular category among investors.

The success of U.S. stocks is evident in the emergence of several household names, whose products and services we encounter daily. Consider companies like Apple (AAPL), Amazon (AMZN), Netflix (NFLX), Meta (META), Microsoft (MSFT), etc.

The U.S. is also recognised for producing global enterprises with leading positions in many markets and sectors.

Some examples of U.S. brands recognised around the world include Disney (DIS), Johnson & Johnson (JNJ), Coca-Cola (KO), 3M (MMM), and Activision Blizzard (ATVI).

U.K. stocks

U.K. stocks offer great choices for investors looking to trade leading finance companies as well as top players in the oil and energy sectors.

Some prominent U.K. stocks in finance and banking include Lloyds’ Banking Group (LLOY), London Stock Exchange Group (LSEG), Standard Chartered (STAN) and Wise (WISE).

Meanwhile, for oil and energy, investors will find Shell (SHELL), BP (BP), National Grid (NGRID), Petrofac (PFC) and thermal solutions provider Spirax-Sarco (SPX).

There are also well-known U.K. stocks covering other sectors, such as Burberry Group (BRBY), GlaxoSmithKline (GSK) and Rolls-Royce (RR).

E.U. stocks

Several European companies have also found significant success on the international stage, with many becoming brand names that hold integral roles, especially in the lifestyle and leisure sectors.

Some stock that come to mind include French fashion house Christian Dior (CDI), Essilor Luxottica (EL), Hermes International (HRMS), L’Oreal (OR), and of course, Moët Hennessy Louis Vuitton (LVMH).

But besides world-leading luxury brands, E.U. stocks also encompass important industry members, including the likes of Renault (RNO), Carl Zeiss Meditec (AFX), Airbus Group (AIR), Danone (BN) and Dassault Systemes (DAST).

A.U. stocks

Australia and New Zealand is another region that investors can look to when choosing stocks to trade. You’ll find a good number of companies that deal with mining and resources, offering diversification options.

A.U. stocks available for trade include metal companies such as Bluescope Steel Limited (BSL) and Fortescue Metals Group (FMG), mining and energy businesses including Pilbara Minerals (PLS), AGL Energy (AGL) and Origin Energy (ORG).

Other noteworthy A.U. stocks include national carrier Qantas Airways (QAN), insurers QBE Insurance Group (QBE) and Insurance Australia (IAN), as well as regional retailer Coles Group (COL).

2.8 Stocks vs stock CFDs

Conventional stock trading involves buying stocks at low prices and selling them at a higher price to realise capital gains, as well as applying more advanced techniques such as shorting to take advantage of market downturns.

As trading methods involve dealing with the actual shares of the underlying companies, investors may encounter constraints, such as insufficient capital to execute the desired trade.

Contracts for Difference (CFDs) offer an alternative way to trade popular stocks without having to take direct ownership of company shares. This is a type of financial derivative that allows investors to seize trading opportunities on the price action of an underlying stock or asset, and potentially benefit from the price volatility that is an inherent feature of the stock market.

Instead of buying and selling stocks over an exchange, stock CFD settlements are based on the difference in prices between the opening and the closing of the contract. Investors can also take both long and short positions ontheir stock CFDs, allowing them to apply both bullish and bearish strategies.

Also, stock CFDs are tradeable using leverage, which means an investor can start trading with a smaller upfront capital compared to purchasing stocks, especially costly blue-chip stocks.

Stock CFDs have their downsides too. Investors do not own any of the shares traded, which means they will not be entitled to shareholder benefits such as dividends. Also, while trading with leverage can amplify profits, it will also magnify losses to the same degree. Thus, leveraged stock CFDs may not be suitable for all investors.

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Module recap

  • Some common groups of stocks include blue-chip stocks, growth stocks, dividend stocks and international stocks.
  • Stocks may also be categorised according to their levels of market capitalisation. Small-cap stocks have market caps of between USD 300 million to USD 2 billion; mid-cap stocks, between USD 2 billion and USD 10 billion; and large-cap stocks, USD 10 billion and more.
  • Blue-chip stocks are recognised for their top-notch quality and proven track record, subject to market conditions. They stand out as one of the preferred choices for investors aiming to anchor the core of their portfolio, albeit often at a relatively high cost.
  • Growth stocks are expected to outperform the market over time. They usually are younger companies with unique or innovative products or services, have a record of increasing profitability, show high return on equity (ROE) and have manageable debt levels.
  • Overvalued stocks are priced at levels that exceed their recent performance, and investors usually refrain from purchasing them until their prices undergo a correction. Undervalued stocks are priced less than their inherent worth, and might experience a price spike when the rest of the market takes notice.
  • Stock CFDs are financial derivatives that allow investors to reap the potential benefits of popular stocks without direct ownership of shares. They offer advantages such as lower starting capital and ability to trade with leverage, but also come with downsides such as no shareholder rights and the potential for losses to exceed capital.

References:

  1. “Mapped: The Largest Stock Exchanges in the World – Visual Capitalist” https://www.visualcapitalist.com/largest-stock-exchanges-in-the-world/ Accessed 19 Dec 2023
  2. “The NYSE Listed Company Network – NYSE” https://www.nyse.com/network Accessed 19 Dec 2023
  3. “Small Cap Stocks vs. Large Cap Stocks: What’s the Difference? – Investopedia” https://www.investopedia.com/articles/markets/022316/small-cap-vs-mid-cap-vs-large-cap-stocks-2016.asp Accessed 19 Dec 2023
  4. “Understanding Small Cap, Mid Cap & Large Cap Stocks – VanEck” https://www.vaneck.com/us/en/blogs/moat-investing/understanding-market-capitalization/ Accessed 19 Dec 2023
  5. “Growth Stock: What It Is, Examples, vs. Value Stock – Investopedia” https://www.investopedia.com/terms/g/growthstock.asp Accessed 19 Dec 2023
  6. “Investing in Growth Stocks – The Motley Fool” https://www.fool.com/investing/stock-market/types-of-stocks/growth-stocks/ Accessed 19 Dec 2023