There are two types of stock, common and preferred—and a wide array of classes and subclasses.
All publicly traded companies issue common stock. If you hold common stock, you're in a position to share in the company's success or feel the lack of it. The share price rises and falls all the time—sometimes by just a few cents and sometimes by several dollars—reflecting investor demand and the state of the markets.
The issuing company may pay dividends, but it doesn’t have to. If it does, the amount of the dividend isn't guaranteed, and the company can cut the amount of the dividend or eliminate it altogether.
Some companies also issue preferred stock, which usually guarantees a fixed dividend payment similar to the coupon on a bond. This might make preferred stocks attractive to people looking for income. Dividends on preferred stock are paid out before dividends on common stock.
The price of preferred stock, however, doesn't move as much as common stock prices. This means that while preferred stock doesn't lose much value even during a downturn in the stock market, it doesn't increase much either, even if the price of the common stock soars.
An important additional difference between common stock and preferred stock has to do with what happens if the company fails. In that event, there is a priority list for a company's financial obligations and obligations to preferred stockholders must be met before those to common stockholders. On the other hand, preferred stockholders are lower on the list than bondholders.
Learn more about what bankruptcy means for shareholders.
Classes of Stock
Certain companies may have different classes of shares, typically designated by letters of the alphabet—often A and B.
A company might offer a separate class of stock for one of its divisions that was a well-known company before an acquisition. Or a company might issue different share classes that trade at different prices, have different voting rights or different dividend policies.
For many companies that have dual share classes, one share class might trade publicly while the other does not. Nontraded shares are generally reserved for company founders or current management. There are often restrictions on selling these shares, and they tend to have what's known as super voting power. This makes it possible for a group of shareholders to own less than half of the total shares of a company but control the outcome of issues put to a shareholder vote, such as a decision to sell the company.
How Stocks Are Grouped or Described
Industry experts often group stocks into categories, sometimes called subclasses. Each subclass has its own characteristics and is subject to specific external pressures that affect the performance of the stocks within that subclass at any given time.
Here are some common stock subclasses.
You'll frequently hear companies referred to as large-cap, mid-cap or small-cap. These descriptors refer to market capitalization, also known as market cap and sometimes shortened to just capitalization. Market cap is one measure of a company's size. More specifically, it's the dollar value of the company, calculated by multiplying the number of outstanding shares by the current market price.
There are no fixed cutoff points for large-, mid- or small-cap companies, but you might see a small-cap company valued at less than $2 billion, mid-cap companies between $2 billion and $10 billion, and large-cap companies over $10 billion—or the numbers might be twice those amounts. You might also hear about micro-cap companies, which are even smaller than other small-cap companies.
Industry and Sector
Companies are subdivided by industry or sector. A sector is a large section of the economy, such as industrial companies, utility companies or financial companies. Industries, which are more numerous, are part of a specific sector. For example, banks are an industry within the financial sector.
Part of creating and maintaining a strong stock portfolio is evaluating which sectors and industries to invest in at any given time. Having made that decision, you should always evaluate individual companies within a sector or industry you've identified to focus on the ones that seem to be the best investment choices to help you achieve your goals.
Defensive and Cyclical
Stocks can also be subdivided into defensive and cyclical stocks, depending on the way their profits, and their stock prices, tend to respond to the relative strength or weakness of the economy as a whole.
Defensive stocks are in industries that offer products and services that people need, regardless of how well the overall economy is doing. For example, most people, even in hard times, will continue filling their medical prescriptions, using electricity and buying groceries. The continuing demand for these necessities can keep certain industries strong even during a weak economic cycle.
In contrast, some industries, such as travel and luxury goods, are very sensitive to economic ups and downs. The stock of companies in these industries, known as cyclicals, might suffer decreased profits and tend to lose market value in times of economic hardship as people try to cut down on unnecessary expenses. But their share prices can rebound sharply when the economy gains strength, people have more discretionary income to spend and their profits rise enough to create renewed investor interest. Thus, their stock price generally tracks with economic cycles.
Growth and Value
A common investment strategy for picking stocks is to focus on either growth or value stocks, or to seek a mixture of the two since their returns tend to follow a cycle of strength and weakness.
Growth stocks, as the name implies, are issued by companies that are expanding, sometimes quite quickly, but in other cases over a longer period of time. Typically, these are young companies in fairly new industries that are rapidly expanding.
Growth stocks aren't always new companies, though. They can also be companies that have been around for some time but are poised for expansion—perhaps because of technological advances, a shift in strategy, movement into new markets, acquisitions or other factors.
When a growth stock investment provides a positive return, it's usually because the stock price moved up from where the investor originally bought it—and not because of dividends. Most growth stock companies tend to plow gains directly back into the company rather than pay dividends.
Value stocks, in contrast, are investments selling at what seem to be low prices given their history and market share. If you buy a value stock, it's because you believe that it's worth more than its current price. Of course, it's also possible that investors are avoiding a company and its stock for good reasons and that the price is a fairer reflection of its value than you think.
If you deliberately buy stocks that are out of fashion and sell stocks that other investors are buying—in other words, you invest against the prevailing opinion—you're considered a contrarian investor. Contrarian investing requires considerable experience and a strong tolerance for risk, since it may involve buying the stocks of companies that are in trouble and selling stocks of companies that other investors are favoring. Being a contrarian also takes patience since the turnaround you expect may take a long time.