The stock market can be an intimidating place for new investors. Between the financial jargon that is thrown around regularly by commentators and market volatility, it can be hard to know where to start with stocks. Fortunately, stocks aren’t as complex as they may seem, and while there are many different categories of stocks, they all have a lot in common. Here’s what you should know about the different types of stocks.
Common stock is probably what you think of when you are looking to invest in stocks. Common stock gives you an ownership stake in the business with the ability to vote on key matters such as electing the board of directors or adopting certain company policies.
When people hear the word stock, they often think of elaborate charts and flashing prices that move around during the day. But when you buy a stock, you are purchasing a stake in a real business and your long-term returns will be driven by the earnings and overall success of that company. Earnings growth will contribute to a higher share price for common stock owners and enable the company to share those earnings with shareholders in the form of dividends.
Preferred stock is more like a bond than it is a stock. Typically, you won’t have any voting rights, but you will receive dividend payments ahead of common stockholders. Preferred stock is issued at par value and the shares are redeemed at maturity, so you don’t have the opportunity for price appreciation that you do with common shares. Your return will primarily come from the dividends you receive.
Preferred stock may be redeemed prior to maturity, and some preferred shares are convertible into a certain number of common shares. While the opportunity for significant gains is much lower with preferred stock than common stock, the risk is considerably lower too.
The universe of common stocks is quite large, so one way to divide that up is by separating companies based on their market capitalization, or the total value of all their outstanding shares. While there is no clear definition of a large-cap stock, they are generally companies with market caps of $10 billion or more. Large-cap stocks are typically established companies with proven records of profitability and are sometimes called blue-chip stocks.
Investors looking to invest in large-cap stocks might consider purchasing an index fund that tracks a large-cap index such as the S&P 500. This popular index includes well-known companies such as Apple, Microsoft and Walmart.
As you move down in market cap, mid-cap stocks are next, and these companies typically fall between $2 billion and $10 billion. These companies are established, but may still be in the early stages of their growth and can come with the potential for meaningful price appreciation. Broadly speaking, mid-cap stocks may come with less risk than small-cap stocks, but more risk than large-caps, although it will always depend on the specific company you’re looking at.
Mid-cap stocks may help to diversify your portfolio away from the large-cap stocks most people typically focus on. Many of today’s large-cap stocks were once mid-cap stocks before growing to new heights.
Small-cap stocks can be one of the most rewarding areas of the market, because they give you the opportunity to identify a company loaded for future growth. Small-cap stocks typically have market caps less than $2 billion and may still be in the early stages of their growth. Because of their small size, small-cap stocks can sometimes be overlooked by fund managers, creating the potential to find hidden gems before the rest of the investment world.
The potential for high returns does come with greater risk, however. Small companies may not be profitable and may have to rely on outside funding to sustain their operations. They can be particularly susceptible to economic downturns when capital dries up and they may not be able to fund their businesses.
Growth stocks are one of the most exciting areas of the stock market, but buying them and earning high returns isn’t as simple as the name suggests. Because high-growth companies can be very rewarding to investors, their prices can sometimes get bid up to overvalued levels where investors won’t earn satisfactory returns. But if you’re able to purchase a growth stock at a compelling price, you may be able to ride its success for many years to come.
Companies like Apple, Alphabet and Tesla have all rewarded investors handsomely in recent years, but only time will tell if their growth can be sustained. Growth stocks are often presented as the opposite of value stocks, but growth can be undervalued by the market. Growth is merely a component of value.
Value stocks might be considered the less exciting cousin of growth stocks, but that doesn’t mean they’re any less rewarding for investors. Just as growth stocks can get bid up to unsustainable prices, other stocks can get beaten down to significantly undervalued levels. The definition of a value stock can vary widely, but when focusing on quantitative metrics, they tend to have lower valuation multiples and lower growth rates than growth stocks.
Some of the world’s most successful investors, including Warren Buffett, have amassed their wealth by buying stocks below their intrinsic value. Be sure to understand the specifics of any stock you buy. Some stocks that look to be a bargain end up being cheap for a reason, and their business declines, dragging the stock price with it.
International stocks are companies that largely do business outside the United States. Some of these companies may have stocks that trade on U.S. stock exchanges to take advantage of the country’s robust capital markets, but their revenues and profits are still generated elsewhere.
Most U.S. investors tend to hold companies that are headquartered in their home country, and for good reason. The U.S. has well established capital markets and is home to some of the most successful companies in the world. However, adding international stocks to your portfolio can help diversify your investments and get a stake in emerging companies around the world.
While there are many different types of stocks, they all represent stakes in actual businesses. No company is inherently a growth or value stock and will likely move between several different categories throughout its life. Always be sure to analyze the underlying business before purchasing a stock to get a sense of the company’s competitive position and valuation.
You can also purchase baskets of different types of stocks by using ETFs and mutual funds that track various indexes. Funds may hold value or growth stocks of all the different market caps. Funds are a great way to get exposure to a certain area of the stock market without having to do a ton of research on individual companies.