If you’re new to stock trading and want to learn how to pick the right stocks, it’s important to know that stocks come in many different forms. Different types of stocks come with varying privileges, levels of risk, and profit potential. If you’re able to determine which kind of stocks best suits your financial situation, skills, and goals, you can find your niche in the multi-faceted world of stock trading and focus your efforts in the right direction. Check out this comprehensive guide to gain a better understanding of the different types of stocks.
- What Are the Different Types of Stocks?
- Common Stocks
- Preferred Stocks
- Growth Stocks
- Value Stocks
- Income Stocks
- How to Choose the Right Types of Stocks
What Are the Different Types of Stocks?
Stocks are a type of investment that allows you to own shares in certain companies. By investing in stocks, you’re actually purchasing a percentage of ownership in a company. For example, if you buy stocks from Apple, you effectively become a "co-owner" of the company. While you may not be invited to the shareholders’ meeting, you may get the right to vote on corporate issues such as the election of the board of directors or approval of takeover bids. While it involves some risk, stock trading is widely regarded as one of the best ways to generate wealth.
Knowing the different kinds of stocks is one of the first things a beginner trader should do. Each type of stock has its own pros and cons, which you need to carefully weigh in order to choose the right type to invest in. There are many different types of stocks, including the two main kinds of stocks and several other less common types. Below are five types of stocks you should know:
If you’re wondering what are the two types of stocks that are most widely traded, one of them is common stocks. When people talk about stocks, they usually mean common stocks. When you purchase common stocks, you’ll get partial ownership in the company that issues the stocks. Also, you may receive dividends and voting rights.
If a company does well or the value of its assets increases, its common stocks will go up in value. However, if it performs poorly, then the value of its common stocks will decrease. Buying common stocks is a great long-term investment strategy because it allows you to share in the company’s success over time.
While they offer the highest profit potential, common stocks expose their holders to greater risk when unfortunate events happen to the issuing company. For example, if a company goes bankrupt, the common stockholders will be the last in line to redeem their shares, behind banks, bondholders, and preferred stockholders. As such, common stockholders often get nothing when companies restructure or go bankrupt.
Preferred stocks are the other main type of stocks. Just like common stocks, they represent a share of ownership in a company. Typically, the dividends that stockholders receive from preferred stocks are greater than those that come with common stocks. Also, the dividends are fixed while payments from common stocks may vary depending on the net profit of the company. Another advantage of preferred stocks is that they allow their holders to redeem their shares before common stockholders in the event that the company gets liquidated. However, preferred stockholders don’t have voting rights.
There are two types of preferred stocks: cumulative and non-cumulative preferred stocks. In cumulative preferred stocks, dividends that aren’t distributed to the stockholders are accumulated in an account. These dividends are called "in arrears." Before any dividends can be distributed to common stockholders, the full "in arrears" balance must be distributed to preferred stockholders first. In non-cumulative preferred stocks, stockholders don’t have the right to claim unpaid or omitted dividends even if the company generates substantial profits the following year.
Growth stocks are shares in a company that are showing above-average earnings and growth potential that surpasses that of the overall economy. Unlike common and preferred stocks, these types of stocks don’t pay dividends since companies tend to reinvest their profits to accelerate their growth in the short term.
If you decide to invest in growth stocks, you’ll earn money through capital gains when you eventually sell your shares. Therefore, growth stocks are considered riskier compared to common and preferred stocks. You’ll be rewarded with high capital gains if the company does well, but you’ll take a loss if it performs poorly. Companies that issue growth stocks are typically from the technology and biotech sectors.
Not all growth stocks are created equal. If you’re interested in this type of stock, you need to be on the lookout for the following four characteristics:
- The company needs to have a stellar management team with a good track record for being innovative.
- The company needs to have a significant market share in a fast-growing market.
- The company needs to cater to a massive market.
- The company needs to have a strong record of revenue growth.
Value stocks are stocks that trade at a lower price relative to a company’s earnings, sales, dividends, and other business fundamentals. When investing in value stocks, investors try to capitalize on inefficiencies in the market since the prices of value stocks aren’t necessarily indicative of the issuing company’s performance.
Value stocks typically come from mature companies that are consistently paying dividends but have a negative reputation or image because of certain events, such as product recall, legal problems, or unsatisfactory revenue reports. As such, value stocks are regarded as riskier than growth stocks. For value stocks to become profitable, the market must change its perception of the company.
One of the advantages of value stocks over other types of stocks is that they offer excellent profit potential. However, it can be extremely challenging to identify these stocks. You can analyze companies comprehensively and still arrive at a wrong conclusion. Also, value investing requires a lot of patience. It can take years before value stocks become profitable. There’s also the possibility that the market will never change its perception toward the company.
Simply put, income stocks are stocks that pay consistent and steadily-increasing dividends. These stocks are less risky than the other types of stocks and pay higher-than-market dividends. Many investors classify income stocks as defensive stocks, which are shares from companies that provide services and goods that are generally needed regardless of the shape of the economy. Keep in mind that defensive stocks are different from defense stocks, which are shares of companies involved in the production or sale of military equipment and goods.
A perfect example of income stocks is those of retail giant Walmart. Over the last 30 years, Walmart’s stock price has risen consistently. This enabled the company to pay rising dividend yields to its stockholders. In 2015, Walmart’s dividend yields peaked at 3.32% despite facing a threat from e-commerce stores such as Amazon.
Income stocks suit conservative investors who want some exposure to corporate growth profit but prefer a low-risk, consistent source of income. You can find income stocks in almost any industry, but they’re most common in the real estate, natural resources, utilities, and financial sectors.
How to Choose the Right Types of Stocks
Now that you know the most common types of stocks, you can start learning how to choose the right kinds of stocks to purchase. This can be daunting, but you can simplify the process by implementing the following trading tips:
- Consider the level of risk you’re willing to take.
- Choose a company with long-term growth potential.
- Buy stocks that complement your other investments.
- Start by buying one stock and then analyze the results.
- Learn how to use trading charts as they can help you understand stock movements.
- Be patient and disciplined because results don’t happen overnight.
With thousands of stocks in the stock market, it can be difficult for a new trader to know which ones to choose. Knowing the different types of stocks enable you to narrow down your options and make better-informed decisions. You can further narrow your options by classifying stocks according to size and sector. If you think of stocks this way, it’s easier to diversify your investments and lower your risk. If you want to learn more about choosing the right types of stocks, consider joining our free, seven-day RagingBull Bootcamp to get real-life tips from our millionaire trading experts.