Types of Stock
There are two basic types of stocks: common stock and preferred stock.
A common stock is the foundation for all corporations, large or small, because it represents ownership of a company. As a shareholder, you become an owner "in common" with other shareholders. As a result, you share the profits and losses of a firm. If the company is profitable, shareholders of common stock benefit the most with higher dividends and capital appreciation. The downside is common shareholders have lower priority claims against the assets of a company, behind bondholders, creditors, and preferred stockholders in a case of bankruptcy or liquidation.
A preferred stock is more like a bond than a stock. It has priority with regard to payments of dividends and claims of company assets. Like a bond, it pays dividends (fixed income) but has no ownership interest. Investors buy preferred stocks for income purposes. Some types of preferred stock can be converted to common stock.
Stocks come in every shape and size. Some offer higher returns at greater risk, while others yield little but with more safety. The broad range of stocks can be broken down into several categories:
1. Growth stocks. This general term applies to any stock that has a good chance of growing faster than the stock market in general. Investors buy growth stocks because they expect their value to go up in the future. These stocks include well-known companies such as Microsoft, Intel, Amgen, and Dell; also obscure ones such as Luby's Cafeterias.
2. Blue-chip stocks. Blue-chips refer to those companies that have had and will continue to have good records. Those who invest in blue-chip stocks want some growth but primarily seek a safe investment. Some examples of stocks in this category are GE, Coca-Cola, and Disney.
3. Income stocks. These stocks pay fairly high dividends, often providing the stockholder with a decent income. Utility companies, real estate, and chemical stocks fall into this category.
4. Cyclical stocks. Stocks in this category react sharply to turns in the business cycle. They do well in a strong economy but drop in a recession. The stock of automobile manufacturers, airlines, and steel companies can be considered cyclical stock.
5. Defensive stocks. People buy defensive stock in order to protect themselves against a recession. The business cycle does not greatly affect industries such as food, beverage, and tobacco, which people use regardless of the economy.
6. Speculative stocks. As the name implies, these stocks are extremely risky investments. Investors who purchase speculative stocks hope for a spectacular profit which usually never materializes. Some examples of speculative stocks are penny stocks and extremely high P/E stocks.
Of course, one stock can fall into many categories. The key is to understand what you can expect from different types of stocks.