If you are just starting to learn how to invest in the stock market, no doubt by now you have noticed that there seems to be many different types of stocks that you have the option of investing in. In this article, you will discover the different types of stocks you can invest in and the pros and cons of each type of stock.
Technically, there are two types of stock that people own: common stock and preferred stock. However, when people are talking about buying and investing in stocks, they are talking about common stock. Below, you will discover what each of these types of stock is and the subsets of those types of stocks.
Different Types of Stock: Preferred Stock
Preferred stocks are an unusual type of stock that act much more like a bond than common stock does. Typically preferred stocks are sold at a predetermined cost by a company (you buy them through a brokerage like any other stock) and preferred stockholders are then given a preset interest rate in the form of dividends.
These stocks over the long run are typically not as profitable as common stocks, but they also are less likely to lose value simply because when a company goes bankrupt, preferred stockholders are paid off first.
Types of Stock to Invest In: Common Stock
Common stock is the type of stock that most people hold and is the kind you typically buy through a broker. When you buy common stock, you become an investor in a company. The prices of the stock you purchase then become an issue of supply and demand; as the company you invest in becomes more valuable, so do the stock prices of that company.
When you purchase common stock, you are buying a small piece of a company, which may entitle you to voting rights (depending on how that particular company’s stock is set up).
People purchase common stock because they hope it will grow more valuable over time. Given that ownership of common stock represents a piece of a company, smart investors who know how to invest will try to find companies that they either think will grow rapidly (which will make their ownership in the company more valuable) or big companies going through tough times whose stock prices have fallen below the company’s real worth.
The downside to owning common stock is that if a company goes bankrupt, your shares may be worth virtually nothing. When a company goes bankrupt and its assets are liquidated or sold, common stock holders only are paid for whatever is left after all debtors and preferred stock holders have been paid off (which is typically little to nothing).
Types of Stock to Invest In: Caps
Stocks are typically divided into a further subset of caps (shortened from market capitalization), which is a classification of the size of a stock. It is represented by the share price multiplied by the number of shares owned by investors. For example, if a company was trading at 10$ a share and had sold billion shares of stock, the market cap would be 10 billion.
There are three major classifications of caps and are large cap, mid cap, and small cap. Individual brokerages and stock sites often set their own ranges for what these caps fall under, but typically:
- Large Caps have a market cap of 10B or higher. Learn more in our article: What Are Large Cap Stocks.
- Medium Caps have a market cap of 2-10B
- Small Caps have a market cap of under 2B. Learn more in our article Investing in Small Cap Stocks.
Given the large ranges, some brokerages add on an additional category on top of large caps known as Mega cap stocks, which are the largest companies in the world with a market cap of 50-100B or more (depending on the brokerage).
Additionally, some brokerages will consider small caps to be companies between 100M-2B in size, and then have another category known as micro caps for smaller companies. Even further, some brokerages will add in a section for “nano caps” which will be all companies under 10-50M in size.
For this reason when using caps as an indicator of a stock’s size, you have to be careful to know exactly what your brokerage considers each cap to be.
The advantages of investing in different caps are pretty simple: the largest cap stocks tend to increase in price slowly, but are are so big they rarely take drastic dives in price. Smaller cap stocks on the other hand have much more potential for growth but also have a much larger potential to go bankrupt. Small cap stocks offer more potential reward but also more risk.
Think about it this way: it is much easier for a company to increase its value from $50M to $500M (effectively a 10-times increase in stock price), whereas a company valued at $200B is not going to be able to increase its value to $2000B. On the other hand, a company that is only worth $50M can easily fall to being worth only half that or even go out of business, whereas a company with $200B is not likely to disappear overnight.
Stock Market Sectors
Another way stocks can be divided is into different types of sectors. The reason stocks are divided into sectors is because different stocks thrive based on differing market conditions. For example, the consumer goods sector is largely considered to be “recession proof” since consumers will always have to buy toiletries and food.
You can learn about all the different sectors and what companies fit into each sector in our Stock Market Sectors List.
Different Types of Stock to Invest In Conclusion
People just looking to get into the stock market should consider investing in common stock by buying into large-cap stocks. Small and mid-cap stocks definitely can be a good investment, but due to the high risk, you should be intimately familiar with these industries and have good market knowledge before committing to these riskier types of investments.