The Basics of Stock Investing – Part 3

Note from Marj: This fantastic series of posts is contributed by The Investment Club Network (TICN). TICN GB Ltd kindly agreed to help us with our financial education so TICN will be running a mini-course about investing here in easisell.com/blog! We’ll publish one article every 4 days so you can learn in bite-size chunks.

I can personally vouch for the quality of support and education TICN offers – it’s world class and they are really serious about working with you towards your financial freedom. If you really want to be financially free but never took the time to learn how to invest, now is the time. I strongly urge you to commit to this mini-course and start investing in yourself and in your financial education now!

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Course Contents

• The Basics of Stock Investing – Part 1
• The Basics of Stock Investing – Part 2
• The Basics of Stock Investing – Part 3
• The Basics of Stock Investing – Part 4
• The Basics of Stock Investing – Part 5
• The Basics of Stock Investing – Part 6

Different Categories of Stock

Professionals divide stocks into various categories attempting to narrow the list of stocks that will meet their investment needs. Stocks may be divided into categories such as: size or market capitalization (large cap, mid cap, small cap, etc); some may be separated by industry such as technology or energy, while others are divided by relative sensitivity to the economic cycle such as growth and cyclical.

Stocks may be divided into the following common categories.

Don't treat investing as a betting game

• Cyclical Stocks
• Defensive Stocks
• Income Stocks
• Growth Stocks
• Emerging-growth Stocks
• Blue Chip Stocks
• Speculative Stocks
• Value Stocks

As you can see by the different categories, each stock has its own set of characteristics. Separating stocks is not always clear and precise, because a stock may fall into several categories, such as a utility stock, which can be classified as both a defensive and an income stock. Below is a brief description of some of the different types of stocks.

Cyclical Stocks

Industries usually classified as cyclical stocks include: chemical, machinery, airline, railroad, steel, paper, and automotive. Cyclical stocks are companies whose profits and earnings are tied to the economy and whose stock prices fluctuate with the business cycle. The company’s profitability is increased and its stock rises when economic conditions are good. Conversely, when the economy worsens, the company’s business falls off, with the company’s profits and stock price.

Defensive Stocks

Defensive stocks include: electric and gas utilities, food, beverage, and drug companies, and are characterized by their degree of stability during periods of economic uncertainty and decline. Anything that is considered to be in the category of human needs and/or vices is thought of as a defensive stock. These companies may lack the appeal of high-growth companies, but are considered to be recession-resistant companies.

Income Stocks

Some stocks are classified as income stocks, because they pay higher than average dividends, and investors, especially the elderly and retired, buy these stocks for the purpose of current income. Careful attention must be given to these stocks, because a high dividend yield does not always insure safety. For example, the price of a stock may have fallen over concerns about the safety of the dividend, thus a high yield is the result. In addition, the stock could be in an industry that is not favored and is believed to have no future. In order to avoid mistakes, investors should buy quality stocks that have had a steady trend in rising dividends.

Growth Stocks

These are generally companies whose sales, market share, and earnings are growing faster than the general economy and their industry average. These companies are usually involved in research and are more aggressive than others. Furthermore, they reinvest their earnings back into the business to facilitate this growth. Because investors generally place a higher value for this above-normal growth, the price-earnings ratios of these stocks will be higher than their counterparts and average stocks, and the dividend if any will usually be lower.

Emerging-growth Stocks

Technology companies are a good example of a stock in this group. These are usually smaller companies that are emerging and have survived their formative years. They have entered a period of strong earnings and expanding unit sales and profit margins. These stocks are normally traded on the American Stock Exchange (AMEX) or over-the-counter (NASDAQ), and their stock prices may be more volatile, therefore having a higher risk.

Blue Chip Stocks

These companies hold leading positions in their industry and have a long, unbroken record of earnings growth and dividend payments. These stocks are high-grade, investment-quality issues of major companies that have the fundamental strength and size to hold their own during a recession and enough resources to capitalize on an economic recovery. All in all, investors who are conservative and who seek safety and stability, will usually invest in this group.

Speculative Stocks

When investing in a speculative stock, an investor needs to remember the phrase: Caveat Emptor! Buyer Beware! These companies usually have a great story, but lack the earnings, revenue history, and the visibility of the more established companies. The stock price can be highly volatile because there is uncertainty that the company can meet expectations of future earnings and revenue. This is not to say that money cannot be made on these stocks, we just think that an investor should gather enough information to determine whether or not this is a stock with a high potential or a stock with no value other than speculative appeal. Just understand the risk involved up front before investing in a speculative stock.

Value Stocks

Value stocks are basically stocks that appear inexpensive relative to earnings, sales, or other fundamental factors. In the past, the demand for growth stocks and value stocks tend to fluctuate. When value stocks are in favor, growth stocks are usually out of favor. Conversely, when growth stocks are in demand, value stocks lag behind.

Company Sizes – Large, Mid, Small and Micro Caps

Company size is typically based on market capitalization. Market capitalization is the total value of the company’s outstanding shares and is defined as current price per share times the number of total outstanding shares. For example, if a company has 1 million shares outstanding and is trading at a price of $20 per share, it has a market capitalization or market cap of $20 million. Stocks are usually classified as follows:

* Large Cap: $5 billion dollars or more
* Mid Cap: $1 billion-$5 billion dollars
* Small Cap: $100 million–$1 billion dollars
* Micro Cap: $100 million or less

Large cap stocks are usually more stable, mature companies. These generally have lower beta and are not as volatile as small caps, as small cap companies tend to fluctuate more in price but have historically offered higher returns for the higher volatile.

That’s it for Part 3! On Part 4, we will discuss How the Stock Market Works and Why Stock Prices Change.

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The Investment Club Network provides financial education, coaching and support. We organise educational seminars to help you understand the world of investment – and show you how to invest wisely and profitably. We help you understand how prices move, what factors affect them and by what mechanisms the markets reflect these changes.
Our aim is to outperform the stockmarket month on month thereby giving members real increases in asset values. So whether you wish to learn how the stock market operates, trade online yourself, become an accomplished ‘Self Investor’ or become a member of one of our ever expanding number of clubs, TICN can deliver this to you.

Related posts:

1. The Basics of Stock Investing – Part 2
2. The Basics of Stock Investing – Part 5
3. The Basics of Stock Investing – Part 4
4. The Basics of Stock Investing – Part 6
5. The Basics of Stocks Investing – Part 1