Stock Types

A knowledge of stock types is important for the value investor as it may have some bearing on buying decisions, not ony what to buy but when to buy.

A common distinction made between companies is in relation to their size. Size is commonly measured by market capitalization, calculated by multiplying the number of a company's shares outstanding by its stock price per share.

Small cap in the U.S. refers to stocks with a relatively small market capitalization. The definition of small cap can vary but generally it refers to a company with a market capitalization of between $300M and $2.0B. In Australia, a small size company is considered to be from $1M to $250M.

One of the biggest advantages of investing in small-cap stocks is the opportunity to beat institutional investors.

Because mutual funds have restrictions that limit them from buying large portions of any one issuer's outstanding shares, some mutual funds would not be able to give the small cap a meaningful position in the fund.

Mid cap in the U.S. refers to companies with a market capitalization between $2 billion and $10 billion. In Australia, medium size companies vary from $251M to $1.0B.

As the name implies, a mid-cap company is in the middle of the pack between large-cap and small-cap companies.

Large cap is a term used by the U.S. investment community to refer to companies with a market capitalization value of more than $10 billion.

The dollar amounts used for the classifications large cap, mid cap, or small cap are only approximations that change over time. Among market participants and between countries, their definitions vary.

The important consideration for value investors is not so much market capitalization of these stock types, but trading volume and liquidity. Both of these tend to increase with size.

Income shares are shares in companies that historically pay larger dividends compared to other stock types. This type of share can be used to generate income without having to sell the share.

The dividend yield indicates the price of the share relative to the stock price. Income stocks have higher dividend yields.

Growth shares are those relating to entrepreneurial companies experiencing a faster rate of growth than their sector. They are generally identified by lower dividend yields and are commonly involved in acquisitions of other companies (company takeovers).

Growth companies can be more difficult to value as takeovers involve risk and quite often destroy value. I look for companies with a history of successful takeovers before considering an investment in a growth company.

Keeping an eye on the return on capital (ROC) employed by the company is one way to determine whether the takeover added shareholder value or whether it simply increased the ego of the company CEO at the expense of the shareholder.

Blue-chip shares generally refer to companies that have a long history of growth and stability. Coca Cola and Gillette were two of Warren Buffett's favorites - companies that he would consider to hold forever. Woolworths and Cochlear are Australian companies that might be given this label.

This type of company is expected to pay regular dividends and have a steady growth in earnings per share.

But of course nothing in this world remains the same forever and the term 'blue chip' is really a misnomer as strange things have happened to so-called blue-chip companies in the past. Enron comes to mind.

So value investors need to assess stock types not by the label someone prefers to put on them, but by their financial performance over time and the honesty and integrity of the company executives.

Some company shares are affected significantly by economic trends over time and are referred to as cyclical shares. Mining companies, home-building and heavy machinery companies come to mind.

A value investor would look to buy this type of company at the bottom of the cycle when others have lost interest because of the economic gloom, and get out when the economy is going gang busters.

Defensive shares are reallly the opposite of cyclical shares as they tend to maintain more of their value during economic downturns. Think of the staples that people will always need like food, insurance and pharmaceuticals and you will be able to identify this type of company.

Value investors would hold some defensive stocks to reduce the volatility of their portfolios and to prepare for the inevitable downturn after periods of market over-exuberance.

Ordinary shares or common stock are any shares/stocks that are not preferred shares/stocks and do not have any predetermined dividend amounts. An ordinary share entitles the owner to a vote in matters put before shareholders in proportion to their percentage ownership in the company.

Preferred stock or preferred shares in a company have a higher claim on the assets and earnings than common (ordinary) stock.

While preferred stockholders have priority over common stockholders on earnings and assets in the event of liquidation, and they have a fixed dividend (paid before common stockholders), they give up their voting rights and have less potential for appreciation compared to common stockholders.

By having knowledge of stock types, value investors are in a better position to discover value among the variety of stocks available on the market, and so potentially to become more successful investors.

Return from Stock Types to Why are Stocks Good Investments