2013 was a great year for common stock investors with the S&P 500 Index up more than 30%! A major takeaway from Lesson 1-2 was that common stocks should be an important element of nearly every investor’s long-term portfolio. What about the use of the term common stock? It is used quite broadly, as if all common stock is the same, but there are various ways to classify stocks.
One way to describe common stock is by the underlying firm’s size or market capitalization (which is the number of shares outstanding multiplied by the current stock market price). This results in the following classification:
- Large capitalization (or large cap) stocks. These are companies with market capitalization (shares outstanding times price) of generally greater than $10 billion.
- Mid capitalization (or mid cap) stocks. These are companies with market capitalization of between $2 billion and $10 billion.
- Small capitalization (or small cap) stocks. These are companies with market capitalization of less than $2 billion.
- Domestic stocks: These are companies whose major listing and operations are within the home country (such as the United States or Brazil).
- International stocks. These are companies whose major listing and operations are outside the home country and which are considered “developed” by the World Bank and IMF. Generally, this would include the United States, Canada, France, Germany, Japan, Italy, and the United Kingdom.
- Emerging Markets stocks. These are companies whose major listing and operations are from countries not considered “developed” by the World Bank and IMF. These would include countries like South Africa, China, Russia, Brazil and India.
Additional ways to classify stocks are by their sector or industry and by key financial characteristics of the firm. You should note that these classifications are temporary and can differ between investors from one time period to another. Commonly used classifications include:
- Blue-chip stocks: These are the common stocks of the largest and generally best-known firms. There is not a specific list of blue-chip stocks and the stocks that are considered “blue chips” change from year to year. These include companies such as General Electric, IBM, Microsoft, and Procter & Gamble. The phrase “blue chip” relates to poker, where the blue chips are the highest value of chip.
- Growth stocks: These are the stocks of firms that are growing faster than average; these companies generally do not pay dividends and reinvest their earnings. These companies also generally have higher price-earnings ratios and higher price-to-book ratios than the market as a whole. Examples would be Google, Facebook, and Amazon.
- Value stocks: Value stocks are less expensive, compared to the overall market. The companies that offer these stocks generally have lower price-earnings ratios and lower price-to-book ratios than the market as a whole. Often times these will be companies that have experienced weaker than expected earnings or other less than desirable news.
- Income stocks: These are the stocks of firms that pay dividends on a regular basis. These would include utilities, banks, and insurance companies.
- Cyclical stocks: These are the common stocks of firms whose share prices move up and down parallel (highly correlated) to the state of the economy. Auto, manufacturing, and airlines are examples of cyclical stocks.
- Defensive stocks: These are the stocks of companies whose stock prices move opposite or with less volatility versus the overall economy. These can include precious metal miners, energy firms, and other natural resources companies.