What is Stock?

This article should scratch the surface of stocks, teaching you some of the fundamentals you need to know and answer the question, “What is Stock?”

Stock is a piece in the ownership of a company. These pieces are individually referred to as a share. Collectively these shares are called stock.

Common Stock

This is the most commonly held type of stock. Investors purchase these shares in a company speculating that the value of the company will increase and as a result the shares value will increase as well. The difference between the price the shares were bought at and the price the shares were sold at is the profit. For example, if I purchase 100 shares of XYZ Inc. at $20 a share ($20×100= $2,000) and sell those same shares sometime later for $30 a share ($30×100=$3,000) the profit is the difference ($3,000-$2,000=$1,000) between the purchase price and sales price.

Preferred Stock

Preferred stocks are called so due to the fact that they provide their shareholders “preferred” status over common shareholders when the company distributes dividends. Think of them as a hybrid between stocks and bonds.

Though they do get a healthy portion of dividends, preferred stocks do not have any voting rights unlike common stock

Large Cap Stocks

Large-Cap stocks are companies with market capitalization that exceed $10 billion. These are the most well established companies in tried and true industries. Many, but not all of these companies have easily recognizable household names.

Large-cap investment does not normally give you huge gains in the short term, but offers you consistency and relative stability against market fluctuations over time.

Examples of large-cap companies are Ford Motor Company (F), Apple Inc. (AAPL), and Starbucks Corporation (SBUX).

Mid Cap Stocks

Mid-Cap stocks are companies with capitalization that is between $2 and $10 billion. Mid-cap companies typically reside in a sector that undergoes rapid growth.

Though established companies, Mid-cap companies are a riskier investment than more established large-cap companies, but offer a higher potential for growth. Due to their size they can withstand a downturn in the market better than a small-cap company but not as well as a large-cap company.

Large-cap companies often delve into different industries while mid-cap companies typically focus on one industry. If that industry dies, so does the mid-cap company.

Some examples of mid-cap companies are Hanes Brands (HBI), Scotts Miracle-Gro (SMG), and Yeti Holdings (YETI).

Small Cap Stocks

Small-Cap stocks are those of companies with market capitalization between $300 million and $2 billion. These smaller companies offer a chance at greater growth than mid and large-cap companies.

That chance at greater growth however comes at the price of uncertainty. Small-Cap companies are typically more susceptible to economic downturns due to their small size and inability to weather the economic storms.

GameStop (GME), GoPro (GPRO), and Tootsie Roll Industries (TR) are all examples of small-cap companies.

Market Capitalization

You may be wondering what market capitalization is. Well, market capitalization is the dollar value of a company’s outstanding shares. It is calculated by multiplying the number of outstanding shares by the current price of each share.

As an example, if company XYZinc. has 1 million outstanding shares and each share sells currently for $100 the market capitalization (or “market cap” as its more commonly called) of XYZinc. is $100 million dollars. (1,000,000 x $100 = $100,000,000)

Investors often use market capitalization to determine a company’s size. Although the market cap is an important statistic in determining a stocks potential for future value, it should never be the sole statistic to base your stock purchases upon.

Dividend Stock

These types of stock have recurring payments called dividends. Dividends are a distribution of a portion of a company’s earnings to its shareholders. These dividends can pay you as long as you own the stock and the company pays out dividends.

For this reason it is important to invest in established companies with a consistent history of dividend payments. These payments can give you supplemental income. Dividends can be paid out in one of two ways, first dividends can be paid in cash or they can be paid in the form of additional stock. Today the trend from companies is leaning toward dividend payouts to its shareholders but that’s not to say every company is doing it.

Non-Dividend Stock

Non-dividend stocks are those of companies whose stock does not pay dividends to its shareholders. At first this may appear like a horrible deal, but there can be upsides to some non-dividend stocks. Some of these stocks are from the largest companies around and they can give you great returns on your investment even if they don’t offer dividends.

Cyclical Stock

Cyclical stocks follow the trends of the market. Because of this they are more susceptible to market fluctuations then defensive stocks (which we will discuss in a moment). Cyclical stocks are dependent upon the discretionary funds of the buying public. If the economy is good and people have more discretionary income they will buy things like new cars and high end electronics. If money is tight they will not.

Defensive Stock

These type of stocks are also referred to as ‘Non-Cyclical Stocks’ due to the fact that these stocks are resistant to economic cycles. They are stocks of things like grocery stores or food production companies that no matter the state of the economy will have a consistent level of demand.

Defensive Stocks are typically stocks of companies that provide perceived value for their product or service. In a downturn while most companies see less sales, some companies see even greater sales. Some industries that do better during an economic downturn are auto parts companies, hair dye manufacturers and home improvement stores. This happens because people are looking to save money and these companies do exactly that versus more expensive options that are more commonly used during economic high times.

Growth Stock

A growth stock is a share in a company whose projected growth is believed to outpace the growth of the market. Typically, these types of stocks do not pay dividends as the company reinvests their earnings to accelerate the growth of the firm. Due to its lack of dividends and the company’s aggressive growth strategy, growth stock is a short term investment that requires the sale of the stock to see any returns. This approach to growth means that growth stocks are inherently risky however their possible quick returns can be incredibly attractive to some investors.

Value Stock

A value stock is an undervalued stock, not necessarily a cheap stock. This means that the individual share price could either be high or low but it’s perceived value is higher than its current market value. Negative publicity can negatively affect the stock price though its actual value could be more based on its historical market stability. This gives speculators the idea that the company will withstand the bad press and recover accordingly. These types of companies can entice investors because they are relative bargains.

Blue Chip Stock

These are the big boys. It is believed that the term ‘Blue Chip’ was borrowed from poker and refers to the most expensive chips in the game. Blue chip stock are most often large-cap companies that are mainstays in indispensable sectors and have stellar reputations. These reasons lead investors to trust blue chip companies to survive market changes of all kinds. Most blue chip stocks pay out dividends to their shareholders which also makes these attractive to investors.

Penny Stock

If blue chips are the term used for the largest guys around, Penny Stock would be the opposite of that. According the the Securities and Exchange Commission or the SEC as it is commonly referred, Penny stocks are defined as all companies whose price per share is below five dollars. Penny stocks are small-cap (or even micro-cap) companies who are unknown, who normally have poor financials, and limited resources. These make Penny stocks speculative and very risky to investors. It is not uncommon for investors to lose considerable amounts of money by investing in penny stock.

Stock Market Sectors

Stocks are often categorized by the type of business that they are. These are referred to as ‘market sectors’ or just simply ‘sectors’. Here is a list of the 11 commonly accepted sectors:

Energy – Oil and gas production and refining companies.

Materials – Businesses that process raw materials or natural resources. Examples consist of mining, logging, and chemical companies.

Industrials – Companies that produce industrial machinery, construction, manufacturing or infrastructure.

Consumer Discretionary – Retail, media, and clothing companies are the backbone of this sector.

Consumer Staples – These companies supply or make food, beverages and indispensable products.

Health Care – This sector is made up of hospital management, biotechnology, medical device manufacturers and pharmaceutical companies.

Financials – Banks and other financial institutions make up this sector.

Technology – Companies that manufacture electronics, develop software or manage information technology.

Telecommunication – These businesses are internet service providers, satellite companies, cable companies and wireless providers.

Utilities – Water, electricity, sewage and gas companies make up the majority of this sector.

Real Estate – These companies specialize in retail, industrial and residential rental and sales.

Diversification

This leads us to a topic you have undoubtedly heard a lot about. Spreading your investments throughout most if not all of these stock types and sectors is known as diversification. Diversification protects your portfolio from sector and market fluctuations by spreading your risk across the broader market. This is instrumental to building a balanced portfolio.

Summary

Now that we have covered some of the basics, whenever asked, you can answer the question ‘What is Stock?’. Remember this article was a starting point from which to further your knowledge about stocks. I recommend watching videos, taking classes and reading more books and blogs (namely from Kashcalf) about stocks. Lastly, I want to remind you to always consult a professional before purchasing shares of any company.