Do you know Stocks are classified into different categories based on market cap, ownership, business cycles, risk, location and numerous other parameters. And, that’s what we’ll be discussing here, different types of stocks that every investor must know about.
In many ways, equity stocks represent a systematic approach to reaction of an economy’s business practices, which in essence becomes both a guiding hand and regulatory factor. While the long term goal for any business is value addition so that the business, investors and society grows, it is important from a participatory point of view to know the different types and ways action can be done, and the types of stocks involved. Let’s get into it.
Also, note that being such a broad avenue, stocks are classified by a lot of different methods. Let’s discuss a few major ones in detail.
Classification of Stocks: By Market Capitalization
Market capitalization simply refers to the amount of stock of a company available in the market. It is basically market price of a share multiplied by number of shares in the market. They are classified into three types.
1. Large Cap Stocks:
These are companies whose market capitalization is more that Rs. 20000 crores. Basically, these are the companies with a proven track record in the market place, have already proven its mettle and reached or are reaching optimum growth levels and have show ability to withstand market waves. Such companies are also called blue-chip companies.
2. Mid Cap Stocks:
These are listed companies, but more popular on a regional level. It is safe to say that a majority of these are growing companies, and are subject to comparatively higher levels of volatility than large cap stocks. In terms of market capitalization, such companies usually range from Rs. 5000 to Rs. 20000 crores.
3. Small Cap Stocks:
These are new entrants, yet to prove their mettle. These are basically firms in their adolescence, and subject to huge risk and volatility, having a market capitalization of less than Rs. 5000 crores.
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Classification of Stocks: By Ownership
A stock usually represents a stake in the business. Needless to say, shareholders are basically owners of the business, but among them , they have different classes of shareholders with different sets of rights and treatments.
1. Common Stock:
These types of shares whose shareholders basically run the game. These are the primary owners of the company, and have voting rights, but it is not compulsory for the company to pay dividend on such stocks. These stocks have no redemption date and are held in perpetuity.
2. Preferred Stock:
The holders of such stocks have certain preferential rights in the company, for instance they have a stipulated fixed dividend to be paid every year, and in case of liquidation such holders would have the right to assets over common stockholders. They also have a fixed redemption period However, they can’t participate in the management of the company and do not have voting rights. They also have a sub-type among them, known as hybrid stock, which are basically preferred stock but with an option to convert into equity/common stock upon redemption.
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Classification of Stocks: By Risk & Investment Cycle
While the aforementioned categories have a particular numerical value or qualitative aspect that differentiates between them, note that differentiating stocks based on investment cycle do not have such crystal clear classification, i.e. the same stock can be a growth during initial years and value during next few years.
1. Growth Stocks:
These are stocks of the companies which are, usually, newer entrants, or to be more precise on an early stage in their business life cycle. These stocks are basically of businesses who are more oriented towards expanding and capturing new markets, and are more likely to retain their earnings to do so, hence a lower probability of dividend. But they make up for this in terms of value growth.
2. Value Stocks:
The basic idea behind classifying stocks as value stocks is simple, it is in the fact that the associated business has more assets or potential than what is currently reflected through it’s stock price. Oversimplifying, these are undervalued stocks, more likely to show value growth.
3. Income/Dividend Stocks:
Income Stocks are basically stocks of companies on a much more mature stage on their business life cycle, hence these stocks are often of large-cap well established companies. Such stocks have a stable stream of dividend, and are less likely to face huge volatility in either of directions.
Classification of Stocks: By Risk & Business Cycles
The above category also talks about business cycles, so to clarify, in that, we focus on the Life Cycle of a business which goes from inception, growth, maturity, decline, to eventual demise or growth again (growth due to introduction of new product, new service, etc). In this one, business cycles refers to the stock’s reaction to bearish and bullish trends of the market.
1. Cyclical Stocks:
Such stocks move with the market, so to say, they grow in value and rise in prices during bullish trends of the market and fall during bearish trends. Another way to look at this can be these are the stocks of companies whose products cater to non-essential/non-addictive markets, such as car and motor companies, tourism, etc.
2. Non-Cyclical/Defensive Stocks:
These are the stocks whose movement does not depend on market bullish/bearish trends, so to say they still continue to grow, or stay comparatively very stable even during bearish trends. These can be companies with products like food, medicine, etc. These can also be addictive substances like tobacco or alcohol products.
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Classification of Stocks: By Location
Such classification might seem obvious, but lack of understanding on this might sometimes lead to confusion, and even mistakes on investor’s part. For instance, consider this, it is more likely that a local subsidiary is more likely to get into trouble when the parent company gets into trouble at some part of the world than vice versa.
1. Domestic Companies:
These are the local businesses and companies which usually have listing on only one country’s indexes. From a purely probabilistic perspective, such companies are also more likely to be mid or small cap companies, with exceptions of course. This category also includes multinational corporation’s local subsidiaries (It is highly unlikely that McDonald’s India would be registered, in say Hong Kong.)
2. International Companies:
These companies include multinational companies, as well internal domestic companies as well. The basic idea is that these are the companies not listed on a local stock exchange, and require an account with an international broker if you want to trade in them.
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Classification of Stocks: Other Important Parameters
The above discussion comprised of different parameters like market cap, ownership, location, risk, business and investment cycle etc. Let’s have a glimpse of a few other important parameters based on which you can classify stocks while deciding and contemplating your investment avenues.
Speculation basically arises from lack of proper information channels or track records for companies without proper analytics (or lack of effort and sheer laziness on an investor’s part.)
However, there are few instances where speculation becomes the only path of analytical decision making that is available, because the company is either very new/unknown. But at the same time, it is not always necessary that stocks with high speculation are bad investments, for example companies like Amazon, Google and Facebook were speculative investments on the investor’s part in the beginning.
Having said that, it is also not a thumb rule that companies with lower speculation and firm market movement in a singular direction are always a good investment (example: Financial Crisis of 2008)
Beta in finance is a numerical value associated with a stock to show how reactive it is to market’s movement. For example, for a company with a Beta of 1, if the market rises by 10 points, so will the company, by 10 points. If beta is higher than 1, the company outperforms the market and if it is lower than 1, it under performs compared to the market.
A positive beta shows positive correlation i.e. if market rises, so does the company. A negative beta shows inverse relationship, i.e. if the market rises, the company’s stock falls.
Stock Types: Categories for Investors & Traders
There a ton of such classifications for stocks available, but the more important aspect is deciding which classification and combinations serves your investment needs. For example, if you’re looking to invest long term, you would prefer blue chip large cap defensive companies with beta around 1, lowering both your risk and market volatility reaction.
Finally, we can say that classification of stocks makes it easy for investors and traders to take a good long term investing decision. You get to see thousands of publicly listed stocks, researching and picking them one-by-one is a cumbersome process. Hence, this division into different types of stocks simplifies your task and helps you study the selected category stocks better.