Types of Stocks

There are various different types of stocks to know about before you get started investing in them.

Types of stocks, explained

There are various different types of stocks to know about before you get started investing in them.

Common stocks

Common stock is what the average person imagines when they think about the stock market. This type of stock gives shareholders the right to vote in meetings and typically yields the highest returns over time. However, there are some drawbacks to common stock.

For instance, common stockholders can receive dividends if the board votes to issue dividends. However, the board is not required to issue dividends to common stockholders.

Furthermore, in the event that a company is liquidated, common stock shareholders may receive some of the proceeds – but not always. We’ll cover this point more in depth below.

Preferred stocks

Preferred stock, on the other hand, does not confer voting rights to shareholders. They also tend to yield lower returns over time. However, preferred shareholders are more protected in certain situations.

For instance, if a company issues both common stock and preferred stock, preferred stockholders will receive a dividend even if and when common stock owners do not. Additionally, preferred stocks can be redeemed on a specific date, similar to a bond.

Growth stocks

Growth stocks are shares sold by a company that an investor believes may have great potential. In theory, as the company expands, so too will the stock’s price. Growth stocks can be either short-term or long-term, depending on how quickly the company realizes its potential. Of course, this growth isn’t guaranteed.

Value stocks

Value stocks, on the other hand, are securities an investor believes to be underpriced. This may be due to an analysis of a stock’s fundamentals or the industry in which the company functions. There are a few key reasons an investor may think a stock to be undervalued, such as:

  • Low P/E ratio
  • High book value
  • Above-average dividends
  • High earnings

What this means for you

There are different types of stocks in which you can invest. They all come with their own pros and cons.

For example, while growth stocks seem like a fantastic deal at first glance, they’re not so black and white. First off, just because an investor believes the company has potential doesn’t mean that the potential actually exists. Furthermore, even if the investor is right about the company’s product or services, there’s no guarantee the market will ever capitalize on the company.

Growth stocks can also look expensive based on certain measures like the P/E ratio. That’s because the stock price is based on a potential big increase in future earnings. Higher prices can mean that growth will likely occur more slowly. Moreover, a company that actively and aggressively pursues expansion may go through cycles of sharp stock price increases followed by dips.

Another downside of aggressively growing companies is that they rarely pay dividends. Because dividends are funded by a company’s profits, a company that throws all of its revenue into expenses and expansion won’t have anything left for its shareholders.

On the other hand, value stocks aren’t always so evident,. For most investors, it takes time and practice to learn the market enough to determine value stocks and make investing in stocks of that kind simple. Even then, it’s easy for an investor to make a bad call, as the market is notoriously fickle.

Value stocks are also about the long game. Some may see rapid growth. But the majority of them experience large returns over a period of years or even decades, rather than months.

That's why the key to any successful investment portfolio is diversification. A mix of stock types—and other assets—can help minimize your risk.

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