Stocks can be one of the most lucrative forms of investment if you know to handle the risks associated with it.
Investors like Warren Buffett, Charlie Munger, Rakesh Jhunjhunwala and others have made billions by investing in the right type of stocks.
But, not all types of stocks are worth investing. Hence, investors should understand the different types of stocks before making any investment decisions.
In this article:
- What are stocks?
- How are Stocks Classified into Different Types?
- What are the types of stocks in India?
- How to Buy your Ideal type of stock?
What are Stocks?
Stocks or shares represent ownership in a publicly listed company. Investors become shareholders of a company by buying its shares. They are entitled to the company’s profits and losses and also get to participate in its future decisions (depending on the type of share hold).
Here’s a video which will explain the concept in a simple way.
How are Stocks Classified into Different Types?
Stocks are classified into various types based on the following parameters:
- Size of the company
- Dividend payment
- Fundamentals of the company
Let us understand each type of stock in detail.
Types of Stocks Based on Ownership
1. Common Stocks
Common Stocks allow shareholders to participate in the company’s profits. They also provide voting rights to the shareholder. Investors who own common stocks of the company have the potential of earning dividends, but these dividends are not guaranteed.
In the long run common stocks have higher returns than any other type of share.
Are common stocks risky?
If a company goes bankrupt, then the company’s creditors (preferred shareholders, bondholders) are paid first. Common shareholders are the last to be paid in times of bankruptcy. Hence common stocks are very risky.
2. Preferred Stocks
Preferred Stocks allow shareholders to have a certain degree of ownership in the company. However, most companies do not offer voting rights to preferred shareholders. In case of preferred shareholders, they get higher, guaranteed dividend payouts. Since they are preferred during bankruptcy, preferred stocks are less risky than common stocks.
3. Hybrid Stocks
Hybrid Stocks are preferred stocks but with an option to be converted into a fixed number of common stocks at a specific time. Hybrid stocks are popularly known as ‘convertible preferred shares’. Since they are a hybrid of common and preferred shares, they may or may not come with voting rights.
Types of Stocks Based on Market Capitalization
Another popular parameter for classifying stocks is Market capitalization. Market capitalization is the total market value of a company. It is calculated by multiplying share price by the total number of issued shares.
There are 3 types of stocks based on market capitalization:
1. Large-cap stocks
SEBI defines the top 100 company in terms of full market capitalization as large-cap companies.
Examples of large-cap stocks in India include Reliance Industries, HDFC Bank, TCS, Infosys etc. Large-cap stocks are also popularly known as “blue-chip stocks.”
The share price of large-cap stocks are stable and experience low volatility. Large-cap stocks provide high dividend yields and are less risky than mid and small-cap stocks. Large-cap stocks are perfect for conservative investors.
[Suggested Reading: Best Blue Chip Stocks to Buy in India Now!]
2. Mid-cap stocks
SEBI defines the companies which rage from 101 – 250 in market capitalization as Mid-cap stocks.
Mid-cap stocks offer higher returns as these companies are in the growing stage. Mid-cap stocks are risky and suitable only for aggressive investors. Mid-cap stocks also include ‘baby blue-chip stocks’ i.e. companies with steady growth but low market capitalisation.
[Suggested Reading: Best Mid-Cap Stocks to Buy in India Now!]
3. Small-cap stocks
SEBI defines the companies from 251st onwards in terms of full market capitalization as Small-cap stocks.
Small-cap stocks are highly volatile and suitable for only aggressive investors with a long time horizon.
[Suggested Reading: Best Small-Cap Stocks to Buy in India Now!]
Types of Stocks Based on Dividend Payouts
1. Income Stocks
Income stocks are stocks which distribute dividends regularly and are known as dividend-yield stocks. Income stocks provide stable returns, consistent dividends and are less risky.
2. Growth stocks
Growth Stocks usually do not pay dividends as the company prefers to reinvest the earnings in its own projects. This reinvestment of profit helps the company grow faster and hence, such stocks are referred to as growth stocks. In growth stocks, investors earn through capital appreciation (rise in stock price).
[Suggested reading: Best Growth Stocks to Buy in India Now!]
Types of Stocks Based on Risk
1. Blue-chip stocks
Blue-chip stocks are stocks of well-established companies with stable earnings and returns. These companies have lower liabilities which helps them pay regular dividends to their shareholders. Also, blue-chip companies provide stable returns and are less risky.
2. High Beta stocks
Research analysts describe ‘Beta’, as a measure of risk. Beta can either be positive or negative. A positive beta means that the stock and the market are moving in the same direction. A negative Beta means the stock and market are moving in opposite directions.
Higher the value of beta, greater the volatility and thus more the risk.
Types of Stocks Based on Price Trends
1. Cyclical stocks
Stocks of companies that are affected by the economic environment and see high price fluctuations are known as cyclical stocks. As the economy starts to boom, the company’s share price tends to rise and vice versa.
Various examples of cyclical stocks are:
- Airline Industry: During strong economic conditions, both individuals and businesses tend to spend money on travel more than during times of Recession.
- Automobile industry: Consumers and businesses tend to buy new vehicles in prosperous times, when the economy is booming and cut back during poor economy.
[Suggested Reading: Best Automobile stocks to buy]
2. Defensive stocks
Defensive stocks are the type of stocks which are unmoved by the economic conditions of the country.
Example: Stocks of FMCG sector, Pharmaceuticals and insurance companies.
Defensive stocks are a preferred investment option among investors when economic conditions are poor, while cyclical stocks are preferred when the economy is booming!
How to Buy your Ideal Type of Stock?
Step 1: Open a Demat Account
Firstly you will have to open a Demat and trading account. Without a Demat and trading account, you cannot trade in the stock markets.
Step 2: Analyse & Decide as per your investment objective
Secondly, you need to analyse the type of stock you wish to invest in as per your investment needs.
Step 3: Monitor your selected stocks
After selecting the type of stock, select the share you want to invest in and monitor the price trends. Make sure you buy the share at a favourable price.
Step 4: Decide what type of order you want to place
There are three types of orders available for you!
Step 5: Buy the Share!
Use your online share trading platform and place the order. On successful execution of a trade, your shares will be credited to your Demat account in two working days after your trade.
With 12 different types of stocks, it can be difficult for investors to select which stock type suits them the most. Hence it is important for investors to analyse their risk profile and investment objective before investing in any type of stock.
Investors should aim to diversify their portfolios across market capitalisation, risk, dividend yields etc.
So take your first little step towards wealth creation with Samco – India’s Best Equity Stock Broker Awarded by CNBC Awaaz!
[Recommended reading: Best stocks to buy in India]