Different Categories Of Stocks

Class Of Ownership

While stocks represent ownership claims on a company's net assets, not all of them are created equal. One common way to categorise stocks is by the class of ownership. There are two main types of stocks that companies issue – common stocks and preference stocks – each of which has different features and terms. Common stocks are the type of stock typically issued by publicly traded companies, and they entitle shareholders to a fraction of the profits a company generates through dividend payments, which can potentially increase if the company does well. As a common shareholder, you also have a say in the company through exercising your voting rights and have a claim on net assets if the company goes bankrupt.

While preference stocks also represent ownership claims on a company's net assets, they often do not have any voting rights and have limited upside potential as dividends payable to preference shareholders are usually fixed. However, preference shareholders have legal priority over common shareholders when it comes to dividend payments. In the case of a bankruptcy, preference shareholders also have the first right of claim to the company's net assets over common shareholders.

Nature Of Industry

Stocks can also be categorised by the nature of the industry in which the companies operate. Cyclical stocks refer to companies operating in industries that are highly sensitive to the business cycle, and whose profits and share prices are tied to the overall strength of the economy. These companies typically sell discretionary items, generating higher revenues when the economy is doing well (as consumers generally have extra income to spend on luxury items when times are good), and lower revenues when the economy slumps (as consumers will usually cut back on their discretionary spending). Automobile manufacturers are prime examples of cyclical stocks. Sales of cars tend to pick up when the economic environment is favourable, but in times of economic recession, when layoffs are a common sight, consumers may well decide to tighten their purse strings and hold off their big ticket automobile purchase.

Defensive stocks (also known as non-cyclical stocks), on the other hand, refer to companies operating in industries that are largely insulated from the business cycle, and whose profits and share prices are less correlated to the overall strength of the economy. Defensive stocks are usually companies that produce or sell daily necessities, such as food, power and healthcare. These are items that consumers are unlikely to cut back on even when times are tough. Healthcare and utility companies are examples of defensive stocks. The GICS (Global Industry Classification Standard) classifies stocks into 10 sectors, all of which are classified either as a cyclical or a defensive sector.

Table 1: Classification Of GICS Sectors

Market Capitalisation

Another common way of categorising stocks is by market capitalisation, which refers to the size of a company and is calculated by multiplying the current stock price of a company by its total number of shares. Generally, stocks fall under one of these three categories: large-cap, mid-cap or small-cap. While there is no universal definition for each of these categories, large-cap stocks are usually companies whose market capitalisations are USD 10 billion and above. Such companies tend to be industry leaders, have stable businesses and are generally believed to be safer investments as compared to smaller and unproven companies. Small-cap stocks usually refer to companies with market capitalisations below USD 1 billion. These companies are relatively unknown and may not be as financially stable as large-cap stocks. However, small-cap stocks offer investors greater growth potential, albeit with a higher level of risk and volatility. Mid-cap stocks fall somewhere in the middle, and are usually companies that have established for themselves a decent record for some time. They offer investors the best of both worlds – stability and the potential for growth – although they are still riskier and more volatile as compared to large-cap stocks.