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Just as it is important to understand that investment is one of the pathways to financial breakthroughs, it is also crucial to understand the basic classification of stocks before venturing into the stock market. Here’s a deep guide on stock classification for beginners.
It is quite undeniable that the stock market has been one of the major channels that have brought many investors to their financial success. Many of these financial stories have been a source of inspiration to a lot of people, thus seeking to venture into the stock market. However, beginners should understand that venturing into the stock market without the right understanding of the various classification of stocks could delay financial breakthroughs and can most especially lead to loss of funds in return. Stocks are classified on different bases depending on their types.
Moreso, it is a matter of fact that there is no investment without risks. Thus, stocks come with diverse risks mostly depending on the type. Investors should understand the shortcomings involved with the stock market, otherwise, they would be on the verge of losing their funds which is definitely discouraging.
Before diving further into the main points of emphasis being the types of stocks and their classifications, it is essential to get an understanding of the meaning of stock itself.
Stocks are also regarded as shares. These represent ownership of the value of a publicly listed company. In this case, investors who by virtue of purchasing a particular company’s stocks are regarded as the company’s shareholders.
This exposes them to being entitled to a percentage of the involved company’s profits and losses. They are also allowed governance rights on the affairs of the company to some extent.
As said earlier, the various types of stocks are classified on different bases which will be fully explained in this section.
Stocks are classified into three different types based on ownership in a company. These are the common stocks, preferred stocks, and hybrid stocks. These stocks in their different forms offer investors different financial potentials.
As the name implies, common stocks are the most common of all. It is most suitable for beginners who have chosen to venture into the stock market. Common stocks are a type of stock that represents a portion of ownership in a company. These stocks offer investors the entitlement to a share of the company’s profit and losses.
The price involved in common stocks is not static as their prices tend to increase when the company is experiencing a surplus. Moreso, common stockholders are granted the benefits of voting rights.
Unlike common stocks, preferred stocks involve an annual dividend of the company’s profit. In this case, investors are offered a fixed amount of dividend on a yearly basis.
The investors of the public stocks tend to enjoy more income only with the company’s creditors, its bondholders, debenture holders. Preferred stockholders get a certain percentage of the company’s funds after the company folds up.
Hybrid stocks come in connection with the common stocks and preferred stocks. They are also regarded as convertible preferred shares. Hybrid stocks are preferred stocks offered to investors with the option to convert them to common stocks at a specified given period. Notably, the option to switch to common stock comes with certain conditions and criteria.
Aside from ownership, stocks are also classified according to the company’s market capitalization that represents the total shares of the company. Hence, a company’s market capitalization is a product of the total number of its shares in the market and the price of the company’s stock at a particular time. There are large-cap, mid-cap, and small-cap types of stocks.
Large-cap stocks are the stocks of public companies that possess large reserves of cash. These stocks represent companies with massive market capitalization. Companies with over $10 billion worth of market capitalization are often regarded as large-cap stock. The large-cap stock tends to involve lesser risk considering the advancement of the company involved and they offer investors the benefits of higher returns when compared to smaller companies.
Quite similar to large-cap stocks, mid-cap stocks are the stocks of medium scaled companies. The market capitalization of these companies is considered medium. These companies are often ranked medium-sized, with their total market capitalization ranging from $2 billion to $10 billion. The mid-cap stock is not the best option for beginners who are yet to understand how to manage risks. This type of stocks tends to be riskier considering that the companies are at their growing stage. It is most suitable for aggressive investors.
As the name implies, small-cap stock represents companies that are considered the smallest among others. They are quite similar to mid-cap stocks as the companies are also at their growing stage. It is most suitable for shareholders who are ready to invest for the long term and are not really concerned about the size of the dividends that are due to them. Companies with a market capitalization ranging between $2 million and beyond are considered as companies with small-cap stocks.
All investments are risky but what distinguishes them is their diverse levels of risk. Thus, stocks are also classified based on their different levels of risk.
These stocks are usually exposed to higher risks than other companies as they often seek to increase the value of the company’s stock. Hence, reinvesting funds into the company while placing investors on a long-term investment plan.
These are stocks of companies that offer dividends to investors in a proportional ratio to the value of the company. These companies offer investors lesser risks as they do not promise substantial growth. They are considered stable companies that can only afford a steady amount of annual dividends.
Quite similar to speculative stock, blue-chip stocks are stocks of limited liability companies that offer consistent returns to investors. These companies are often large and reputable companies that have gained a foothold in the market. Thus, they offer lesser risks to investors considering their tale of good financial performance.
These are companies whose performances are not dependent on the economic situation. They tend to pose lesser risks to investors considering their ability to stand regardless of unfavorable economic situations.
Stocks are classified as growth and value stocks considering the investment methods adopted by the involved companies. Under this category, growth stocks are determined when the company chooses to keep reinvesting its resources including capital from investors till a specified future date. Investors are made to invest on a long-term basis.
Value stocks, on the other hand, represent stocks of companies that perform contrary to the growth stocks. These companies do not reinvest funds but offer a consistent annual dividend to investors which is dependent on the value of the company’s share.
It is a common opinion that companies have diverse ways of rewarding investors. Most companies adopt a dividend payment method where investors are paid with a certain and agreed amount on a steady basis. These are often regarded as dividend stocks.
Meanwhile, non-dividend stocks are those where investors have entitlement to a portion of the company’s shares. Hence they share profits with the companies.
As mentioned earlier, cyclical stocks are stocks of companies whose price trends are easily affected by economic situations. They pose investors to higher risks as they can be greatly challenged by unfavorable market conditions.
Without diving into too many details, non-cyclical stocks are obviously the contrary type of stocks when compared with cyclical stocks. Their price is not dependent on economic conditions.
Blue-chip stocks are stocks of companies with high reputations in the market. These companies have gained incredible footholds and are able to win the hearts of many investors considering their successful histories.
Penny stocks on the other hand are stocks of growing companies that are still striving to gain impressive recognition in the stock market. They pose investors to higher risks as their performances tend to be unpredictable.
Stocks are often classified based on the sector of the companies involved. These sectors include the technology sector, energy sector, financial sector, health care, and lots more.
Investors make choices of which sector to venture into putting into consideration their personal areas of specialization. Each of these sectors operates in diverse ways with different investment conditions guiding them.
The stock market has contributed to the success of many investors who have understood how the market works and have been able to make perfect decisions from their understandings.
Beginners who can as well understand these basic facts about stocks and their diverse classifications are guaranteed to be on a pathway to financial breakthrough.
Stocks represent ownership of a portion of a publicly listed company.
There are common, preferred, hybrid, large-cap, medium-cap, small-cap, defensive, cyclical, blue-chip, growth, speculative types of stocks.
A notable difference between both stocks is the diverse level of volatility in their price trends.
Stocks can be categorized as growth, speculative, blue-chip, defensive stocks based on the level of risk they present.
The types of stocks based on the investment methods are growth stocks and value stocks.