Shares of stock represent ownership in a corporation. Stocks fall under many categories, depending on the size of the company, its prospects and the state of the markets.
Types of Stocks
Stocks in companies whose sales and/or earnings are growing, or are expected to grow, more rapidly than other companies in the same industry or the economy as a whole, are considered growth stocks.
On the other hand, stocks that may be significantly undervalued (cheap) relative to a variety of fundamental and technical criteria are considered value stocks. In other words, the price of a value stock does not adequately reflect the company's internal strengths or market and economic position.
To determine the total investment return of a stock investment, add the stock's dividend (the amount a company pays out in profits to its shareholders) to its capital appreciation (the gain or loss in the overall price of the investment). Stocks in companies that pay out most of their profits as dividends are called income stocks. Other companies (typically growth stocks) opt to reinvest profits in the business, so returns from these investments will depend on capital appreciation.
The size of a company's market capitalization can influence how easily the stock trades, how much information is available on the company and how much risk is involved. To determine a company's market capitalization ("cap"), multiply its current stock price by the number of shares outstanding.
The three sizes of market capitalization for stocks are:
- Large-capitalization (large-cap) stocks, with capitalization of more than $15 billion, frequently offer regular dividends, and the underlying company's size generally lessens the risk of company failure. Information is readily available on these companies.
- Mid-capitalization (mid-cap) stocks, with capitalization of between $2 billion and $15 billion, also have a large volume of shares to trade on major and regional exchanges. But the companies are smaller and less mature than large-cap stocks. Typically, they offer a greater potential for growth than larger companies, but the risk is also slightly greater.
- Small-capitalization (small-cap) stocks, with capitalization of between $300 million and $2 billion, have a smaller volume of shares and, consequently, are sometimes more difficult to trade. The result is that they have the potential for more dramatic growth; however, they also entail greater volatility (their prices may swing from high to low) and involve higher risk of company failure or poor management.
Note: Companies with market capitalization under $300 million are considered microcap, the riskiest group of all.
Stocks or equity investments can also be classified into five broad categories:
- Income Stocks: High-quality, stable companies that have typically modest growth in earnings and pay relatively large dividends to their stockholders. Income stocks may be best suited for conservative investors.
- Blue Chips: Large, high-quality companies in important consumer industries with consistent earnings growth at historically stable rates. Blue chip stocks may be best suited for conservative-to-moderate-risk investors.
- Aggressive Growth: Smaller companies with growth potential in both revenue and market share. Because these stocks tend to have more price volatility than those of larger companies, fast-growth stocks may be best suited for high-risk investors.
- Cyclical: Companies in which sales, earnings, and stock prices tend to rise and fall with overall economic activity or individual industry cycles. Cyclical stocks may be most appropriate for moderate-to-high-risk investors.
- Special Situations: For example, companies with turnaround, asset restructuring, or takeover appeal. High-risk investors may favor this category.
Dow Jones and S&P
The Dow Jones Industrial Average (DJIA) is perhaps the most widely quoted of all the market indicators. It tracks the prices of 30 actively traded large-company stocks on the New York Stock Exchange and generalizes its findings to the market as a whole.
Since the DJIA is based on such a small sample of the market, many investors and analysts pay more attention to Standard & Poor's Composite Index of 500 Stocks (S&P 500). The S&P 500 is a broader, market-weighted index that tracks the stocks of 500 large companies. It should be noted that an investor cannot invest directly in an index.
Market Movement: Bulls and Bears
The stock market rarely proceeds in a straight line. Its movements are more akin to a roller-coaster ride - ups and downs, twists and turns, and the occasional steady course. It's only over longer periods of time that trends become apparent. In addition, the performance of different investment vehicles (stocks, bonds, and cash equivalents) varies over time.
Unfortunately, market volatility cannot be predicted with great accuracy, but there are logical explanations for its occurrence. The origins of market volatility are typically found in the economy, social events, and political activity, here in the U.S. and abroad.
While the past performance of the stock market cannot guarantee future movements, the market has historically moved up and down in recurring cycles. A prolonged period of rising stocks is called a bull market. A market that is steadily falling is labeled a bear market. A complete market cycle can last three to five years or longer.
Advantages and Disadvantages