Different Types of Stocks

Investing in the stock market has historically been the most important path to achieve financial freedom. As you dive into researching stocks, you’ll often hear people discussing different types of stocks with different classifications. Let’s take a look at the types of stocks you should know.

Classification based on Ownership

When an investor purchases shares of a company, he gets certain ownership in the company. However, this ownership will vary based on the type of shares issued by the company. The different types of stocks based on ownership are:

• Common Stock: Common stock is popularly known as Equity Shares. This type of stock offer ownership in the company along with voting rights to the elected board of directors. Equity shareholders are eligible to receive a portion of the profits called as Dividends. If the company gets liquidated, then equity shareholders are the last category of shareholders to get their portion of the money after all the payments are made to the preference shareholders and Debenture holders.

• Preferred Stock: Preference shareholders also get ownership in the company, but these shareholders don’t get any voting rights. When it comes to receiving profits of the company, the preference shareholders will get preference over Equity shareholders to get a portion of the profits. First, Debenture holders will be paid, then Preference shareholders and then the Equity shareholders.

• Convertible Preference Share: These are initially issued as preference shares with an option of converting these shares into common stocks at a specific time. Voting rights for these shareholders will be decided by the company.

Classification based on Market Capitalization

Stocks can be classified based on market capitalization, which is calculated by multiplying the current market price with the total number of shares outstanding in the market.

(Market Capitalization = Total number of outstanding shares X Current market price of one share)

Let’s say a company-issued 1, 00,000 shares at Rs.10 per share and raised Rs.10, 00,000. If the current market price of one share is Rs.40, then the market capitalization of the company is:

Market Capitalization = 1, 00,000*40 = 40, 00,000

Listed below are different types of stocks based on market capitalization are:

• Large Cap Companies: Top 100 companies, as per their market capitalization, are covered under Large-cap companies, often called blue-chip companies. These are established enterprises with large reserves of cash at their disposal. These companies are in their stable phase of the business life cycle. Also, they are well recognized, trustworthy and transparent in their workings; hence investing in these companies is less risky. Large size companies do not grow rapidly.

• Mid Cap Companies: Top 101 – 250 companies, as per their market capitalization, fall under mid-cap companies. These companies have a well-renowned name and have the potential to grow. Mid-cap companies have a good track record and are very similar to blue-chip stocks barring their capitalization.

• Small Cap Companies: The companies that are not classified under either large-cap or mid-cap are Small-cap stocks. Investors who are committed for the long term and are not very particular about receiving dividends can invest in these types of companies and can get a significant gain. Small-cap companies are relatively new in the market, and their stocks are highly volatile and risky.

Classification based on Valuation

The market price of a stock also depends on supply and demand for a stock in the market. The different types of stocks based on intrinsic value are:

• Overvalued stocks: The market price of these overvalued stocks cannot justify their earnings. The market price of these stocks is higher than the intrinsic value of a stock. A company is considered overvalued if it trades at a rate that is unjustifiably and significantly more than its peers. Overvalued stocks are sought by investors looking to short positions and capitalize on anticipated price declines.

• Undervalued stocks: An undervalued stock is defined as a stock that is selling at a price significantly below the assumed intrinsic value.

For example, if a stock is selling for $50, but its worth is $100 based on predictable future cash flows, then it is an undervalued stock. The market price of these stocks is lower than intrinsic value.

Classification based on Economic Trends

These stocks react based on the news about the economy. The different types of stocks based on Economic Trends are:

• Cyclical Stocks: These stocks move in sync with the economy. When the economic trends are negative, the prices of these stocks fall, and when economic trends are positive, the prices of these stocks rise. In a booming economy, one can invest in these stocks. A cyclical stock’s price is affected by macroeconomic or systematic changes in the overall economy. Cyclical stocks are known for following the cycles of an economy through expansion, peak, recession, and recovery. Most cyclical stocks involve companies that sell consumer discretionary items that consumers buy more during a booming economy but spend less during a recession.

• Defensive Stocks: These stocks don’t react strongly to economic trends. These stocks are considered safe to invest in. A defensive stock is a stock that provides consistent dividends and stable earnings regardless of the state of the overall stock market. There is a constant demand for their products, so defensive stocks tend to be more stable during various phases of the business cycle.

Classification based on Price volatility

Some stocks are volatile, and some other stocks are stable. The different types of stocks based on price volatility are:

• Beta Stocks: If the stock has a higher beta, greater than 1, it means that the investment risk is higher.

• Blue-chip stocks: These are the stocks of well-established companies. These are more stable stocks. A blue-chip stock is the stock of a corporation with a reputation for quality, reliability, and ability to operate profitably in good and bad times.

Classification based on Profit sharing

When you become a shareholder of a company, you are eligible to receive a share in the profits of the company as a Dividend. A company can either share the profits of the company to the investors or can reinvest the profits in the company itself. The different types of stocks based on Profit sharing are:

• Income stocks: These stocks offer regular dividend payouts. Income stocks provide income to the shareholders in the form of dividends. These companies grow at a steady pace and are considered low-risk investments.

• Growth stocks: These stocks don’t pay dividends. These companies reinvest the profits in the company to grow their business. Such companies aggressively grow, and hence the stock prices increase rapidly. A growth stock is a stock of a company that generates substantial and sustainable positive cash flow and whose revenues are expected to increase at a faster rate than the average company within the same industry. This helps the investors to book capital gains when the stock prices increase. Growth stocks are considered riskier for investments when compared to income stocks as the profits are based on market prices that can fluctuate beyond the control of the company.

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