A Beginners Guide to the Different Types of Stocks
As a beginner investor, there are many concepts to get your head around, one of which is the terminology that investors use amongst themselves. It may seem arbitrary, but knowing and understanding the different terms can be incredibly useful when attempting to establish yourself as a successful investor.
In particular, when it comes to stocks, knowing and understanding the different types of stocks which exist and the opportunities which they represent can be very helpful. That’s why, in this article, we will be identifying and explaining some of the different types of stocks which you should be aware of when investing or trading in the stock market.
The Different Types of Stocks
Common Stock vs Preferred Stock
We will start our list of the different types of stocks by looking at common stock vs preferred stock. Both these types of stocks represent part-ownership in a listed company, but they differ in a couple of key ways.
Common stock, as implied by the name, is the most common type of stock and it is not unusual for companies to only offer this type of share to their investors.
If the company enters administration, owners of common stock have the right to receive their share of the value of its remaining assets but only after creditors, employees and the tax authorities have received any money they are due. If the company dissolves and no assets remain, owners of common stock will be left with nothing.
This is the main difference between common stock vs preferred stock; preferred stock – again, as the name implies – gives its owners preference over common stock owners should the company enter administration. Specific rights differ but, typically, preferred shareholders are paid dividends before common shareholders and, if both types of stock distribute dividends, the preferred shareholders will often receive a bigger amount.
Value stocks are listed companies which trade on the stock exchange for a relatively cheap price compared to their earnings; in other words, their fundamentals justify a higher value than their current share price.
Value investors, such as the legendary Warren Buffet, mould their investment decisions around identifying and buying these types of stocks with the belief that, at some point, the market will correct itself and their investment will realise its true value.
Value stocks tend to be mature, established companies with consistent results and a history of sound growth – or companies whose assets are not being fully valued by investors.
Growth stocks are often contrasted with value stocks and are usually perceived as a higher risk investment.
Growth investors are mainly focused on finding companies growing at at a faster rate than other businesses, both in the same industry and across the market as a whole. Because of this, growth investors are usually willing to pay more for these shares in exchange for the prospect of larger returns in the future. Growth stocks tend not to pay any dividends because all available capital is reinvested back into the company to fuel future growth.
This categorisation covers a wide range of different types of stocks, all of which pay out a portion of their earnings to shareholders in the form of a dividend.
Not all stocks pay dividends, as we have already highlighted by another of the types of stock on our list – growth stocks. In particular, younger, less-established companies are less likely to pay dividends as, like growth stocks, any additional income tends to be reserved for reinvestment into the company in order to accelerate its development.
ESG stocks are shares of companies which abide by ESG principles, where ESG stands for Environmental, Social and Governance. These principles take into account a company’s wider impact on things such as the environment, employee welfare and ethical business practices, as opposed to solely looking at a company’s ability to generate returns.
These types of stocks are growing in popularity, as investors are increasingly paying more attention to the wider impact of their investments. As such, we are increasingly seeing ESG stocks perform well which further encourages investments based on these principles. After all, who wouldn’t want to earn money whilst also helping make the world a better place?
Blue Chip Stocks
Blue chip stocks is the name given to shares of well-established companies, with a large market capitalisation, a proven track record of success and who have cemented themselves as market leaders in their industry. Think Microsoft, Coca-Cola, Disney and Johnson & Johnson - to name but a few.
Blue chip stocks are usually also dividend stocks, due to the fact that they have already achieved a large amount of growth and are well-positioned to distribute a portion of their earnings amongst its shareholders.
Given their history of providing returns to investors, blue chip stocks tend to be some of the most in-demand types of stocks with investors and are priced accordingly. They are particularly popular with conservative investors who have a low appetite for risk as they are perceived as safer investments and, given their entrenched position in their respective markets, there is indeed a significantly lower risk of ruin when investing in blue chip stocks.
At the complete other end of the spectrum to blue chip stocks, penny stocks are '’down-in-the-dumps' shares which typically cost less than £1 /$1 - hence the name.
These types of stocks are usually high risk due to the fact that the business in question will not be well-established in their particular industry and, therefore, carries a higher risk of failing. You must be careful if considering an investment in a penny stock, don’t make the mistake of thinking you are getting a good deal because they are cheap. More often than not, penny stocks are cheap for good reason!
Now you should be more familiar with some of the most common different types of stocks, which will help you better understand the different investments out there.
Many investors will pick a particular style, such as value or growth investing, and construct their portfolio with this in mind. However, there is no reason why you need to constrict yourself to one particular method of investing. Every investor is different and, besides, portfolio diversification is one of the most effective ways of managing your risk.
Remember, regardless of the type of stock, the most important factor when investing is to thoroughly research the company before putting your capital at risk.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.