Types of Stocks and Their Characteristics

Stock investing is about balancing risk and reward.

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Stock exchanges are home to thousands of stocks of companies in different sectors operating around the world. You should have little difficulty constructing a diversified stock portfolio to suit your financial objectives and risk tolerance. Blue chip, growth, dividend-paying, penny and preferred stocks are some common kinds of stocks you may encounter. Some of these stocks offer steady capital appreciation, while others offer a mix of regular income and modest capital appreciation. Successful investors focus on business fundamentals and ignore short-term volatility, which is a defining characteristic of stocks of any type.

Blue Chip Stocks

Blue-chip stocks represent large established companies, including members of the Dow Jones Industrial Average and other major market indexes. These companies typically have diversified global operations and have predictable earnings and cash flow. The companies are typically leaders in their respective industries. Blue-chip stocks are suitable for all investors because they offer capital appreciation, dividend income and relatively low volatility.

Growth Stocks

Growth stocks represent companies experiencing rapid growth in their respective markets. These stocks often have high ratios of price to trailing 12-month earnings, because investors expect consistently high sales and earnings growth from these companies. These high expectations could mean high price volatility, especially if the companies fail to deliver on profit projections.

Growth stocks are suitable for aggressive investors who are willing to accept price volatility in exchange for potentially high returns on investment. However, rapidly growing companies usually do not pay dividends because they reinvest the surplus cash into operations.

Income Types of Stocks

Some companies pay regular cash dividends to shareholders from after-tax income. After setting aside cash for operations and strategic acquisitions, they return some of the surplus cash to shareholders in the form of cash dividends or stock buybacks. Companies that pay dividends include large companies, electric utilities, real-estate investment trusts and even mature technology companies. Dividend-paying stocks are ideal for conservative investors looking for steady income, low price volatility and some capital appreciation.

Penny Stocks

Penny stocks are inexpensive but highly speculative stocks that generally trade over-the-counter. These are small companies with limited operating histories, revenues and cash flow. Penny stocks usually trade in low volumes, which means that you might not be able to buy or sell positions at favorable prices.

Preferred Stocks

Preferred shareholders do not have voting rights but have preference over common shareholders with respect to dividend payments. Investors tend to buy preferred shares just for the dividend income because there is usually very limited prospect for capital appreciation. Preferred stocks trade in low volumes and are usually not volatile.

Other Types of Stocks

Exchange-traded funds track market and industry indexes, such as the Dow Jones and S&P 500 indexes, but trade just like stocks. ETFs rise and fall with the underlying indexes. You can also buy American depository receipts, which represent whole or fractional shares of foreign stocks. ADR prices reflect the value of the underlying stocks in their home markets.