Stock investing can be a crucial part of personal finance strategy. The primary reason why most people buy stocks is to generate a long-term return on investment that surpasses that of other prominent asset classes. It can be achieved in various ways. But before knowing about stock investing it is important to know the basics of stock. In this article, we will discuss what are stocks and their types.
What is Stock?
A stock is a term used to describe the ownership certificates of any company. On the other hand, the share refers to the stock certificate of a company. Holding a particular company's share makes you a shareholder. Stocks are of two types-
- Common and
- Preferred Stocks
The difference between both the stocks is that the holder of the common stocks has voting rights that can be used in corporate decisions, and the preferred stocks don't.
What does owning a stock means?
Owning a stock means buying a percentage of ownership in the Company, but many investors have a misapprehension about the advantages and responsibilities of being a shareholder. Many of these misunderstandings stem from a lack of understanding of each Stock's amount of ownership. Many investors benefit from both-
- High Dividend yield and
- Price appreciation, some do not.
Also, there is the fact that not all stocks pay dividends, and many suffer from price depreciation rather than appreciation. As a result, active investors avoid establishing highly concentrated positions in a few stocks. Instead, they build diversified portfolios that include diversified companies covering different industries and geographic regions.
Beyond the possible financial benefits, most stocks also offer investors voting rights on essential governance matters. On the other hand, the institutional investors with significant ownership stakes tend to value voting rights highly.
Types of Stock
Not all stocks are the same, so it is essential to understand their differences. Let us understand different types of Stock-
Based on Stock Class
Stocks can be first classified based on the shareholders' voting rights based on stock class. Certain stocks do not give the shareholders the power to vote at the annual meetings and where the decisions regarding the management and such issues occur. However, some other stocks allow shareholders to take part in the decision-making in the matters of the Company by casting their votes. Another kind of stock offer shareholders the opportunity to cast multiple votes on issues pertaining to the Company's different aspects.
Based on Market Capitalization
Stocks can be categorized based on the Company's market capitalization, which is the total shareholding of a company. Market Cap is calculated by multiplying the current price of the company stock with the total number of shares outstanding in the market. Below mentioned are the types of stocks based on market capitalization.
Large Capital Stock
Large-cap stocks are the stocks that are often termed stocks of Blue-chip companies. These stocks are established enterprises with large cash reserves at their disposal. For every investor, it is essential to know that the large-cap stocks of the large-cap companies do not assure that they grow more rapidly. But yes, large-cap stocks do come with the perks of allowing the investors to get higher dividends than the Mid and small-capital companies' stocks.
Medium Capital Stock
Mid-cap stocks are the stocks of companies whose market cap is above Rs 5,000 crore but less than Rs 20,000 crore. Investing in Medium Capital stock companies can be riskier than investing in large-cap market companies. The reason behind this is that a mid-cap tends to be more volatile. On the other side, mid-cap companies also have the potential to turn into large-cap companies in the long run. Hence, these companies offer a higher growth potential than large-cap stocks, so more investors are attracted to investing in such companies.
Small-cap stocks are the stocks that have the smallest value in the market as compared to their counterparts. However, small-sized companies with a market capitalization of below Rs 5000 crores have the potential to proliferate in the future. Investors who are prepared to commit to long-term investment, are not very specific about the current dividends, and are willing to stay pat during price volatility, can make significant gains in the future.
As an investor, you can buy small-cap stocks when they are available at a low price during the Company's early stage. However, there is no surety about how the Company will perform in the market in early stock capital stocks since they are relatively new.
Based on Ownership
Based on ownership, the stocks are categorized into-
Preferred and Common stocks
Preferred stocks are the stocks that offer investors a fixed amount of dividend every year, whereas common stocks do not offer investors a fixed amount of dividend.
The price of preferred stocks is less volatile as compared to common Stock. However, the holder of common Stock gets the advantage of priority when the Company has surplus money to distribute.
Hybrid stocks are issued by the companies that offer preferred shares with the option of converting them to common shares with specific terms and conditions. The option can be availed at a certain point in time. These stocks are known as hybrid stocks
Stocks with embedded derivative options
Companies also issue Stocks with the embedded derivative option, which means that they can be 'callable' and are not available commonly. These stocks are also termed as 'Putable' stocks that have the choice of being bought back by the Company for a certain price at a certain point in time.
Based on Dividend Payment
Income stocks are the stocks that distribute a higher dividend in relation to the share price. Higher dividends reflect higher income, which is known as Income Stocks. Income stocks indicate that the Company is stable and can afford regular dividends, but these companies cannot promise very high growth.
As compared to Income stocks, Growth stocks do not pay high dividends. The companies issuing Growth stocks prefer to reinvest the earnings to enable them to grow faster. The value of the Company's share rises with the fast growth rate, allowing investors to profit through higher returns. Growth stocks are best for those investors who seek long-term growth potential and are not an immediate second source of income.
Classification based on Risk
The level of Risk in Stock differs depending on the price fluctuations. Stocks with higher Risk reward investors with higher returns, while low-risk stocks generate low returns.
The beta stock risk is obtained by calculating the price volatility of the Stock. Beta can be positive or negative, which denotes whether it moves positively with the market or against it. The higher the Beta, the higher the risk quotient of the Stock. If the value of iBeta stock is more than one, it means that the stock is more volatile than the market.
Blue Chip Stocks
Blue-chip stocks are stocks of those companies with fewer liabilities and stable earnings and pay regular dividends. Blue Chip Stocks are issued by large and well-recognized companies and have a long history of sound financial performance.
Classification based on fundamentals
Based on Fundamentals, the stocks are classified into-
Overvalued shares are those with prices that exceed the intrinsic value and are considered overvalued.
Undervalued shares are known amongst the value investors as they believe that the share price will rise in the future.
Classification based on price trends
Based on Price trends, Stocks are classified into-
Defensive stocks are somewhat undaunted by economic conditions and are preferred when the market conditions are bad.
Cyclical stocks are gets affected by economic conditions and see high price fluctuations with market volatility.
Benefits of owning Stocks
Stocks are a valuable part of an investor's investment portfolio. Having stocks of different companies can help you build your portfolio, protect the money from inflation and taxes, and maximize your investments. There are various benefits of owning a stock. A few of the benefits are mentioned below-
- Ownership stake in the Company
- Investment Gains
- Dividend Benefits.
- Higher returns over the short-term period.
- Well protected by the Regulatory authorities.
- Avail of the benefits of a Growing Economy
- Ease of investing in smaller amounts.
- Easy Buy and Sell
Risk of owning Stock
The stock market has provided generous returns to investors over a period of time, but it also goes down; while owning a stock there can be a possibility of both Benefits and risks. Here are some of the Risks of owing Stock-
- Emotional Highs and Lows.
- Common stockholders get paid last.
- Takes time to research the best stocks
- Taxes on Profitable stocks
- Professional Competition
How to do the stock valuation?
Both Investing and trading have gained popularity due to their potential to deliver handsome returns. However, many investors have suffered losses in making the right bets. They either pay an additional amount for Stock or lose some of their capital as they fail to identify the available cheap ones, thereby letting go of the chance to make good money. This happens due to less knowledge about how to do stock Valuation.
When it comes to stock valuation, analysis of the Company's fundamentals is the only way to spot cheap stocks. It is a method of stock valuation by measuring its intrinsic value based on-
- Related economic,
- and Other qualitative and Quantitative factors.
- Absolute valuation and
- Relative valuation.
In the absolute valuation, the analysts value a stock by taking off the Company's free cash flows by a suitable discount rate and calculating the present value.
In relative valuation, the analysts compare the value of the Stock with those of its competitors to check whether it is worth investing in or not. This type of valuation is excellent for quick evaluations and is an easy way to determine the Company's stock valuation.
Difference between Stock and Shares
People often get confused and use the words Stock and shares interchangeably, but there is a key difference between stocks and shares. The terms "Stock" and "Share" are essential in their ways, and the difference is not as indistinct as it may first seem. So, let's take a look on how stocks are different from shares.
We can say that investing in Stock is the best way to earn money and enhance your wealth. When you buy a stock of the Company, you become an owner of the Company. In addition, it offers investors excellent potential for growth over a long period, and the investors who are willing to hold the stocks over a long tenure have been rewarded with positive returns.