So, you decided to buy shares! Before you buy things you don’t understand it’s best to have a clear understanding of the act of investing and the different shares available to trade with. There are different types of stocks to invest in and they can be overwhelming for a beginner investor.
Here’s what you need to know:
Understanding different stock categories can help you make more informed investment decisions and reduce portfolio risk.
You can buy two kinds of stock. All publicly traded companies issue common stock. Some companies also issue preferred stock, which exposes you to somewhat less risk of losing money, but also provides less potential for total return.
When you own common stock, you own a share in the company’s profits as well as the right to vote. Common stock owners may also earn dividends.
In general, preferred stock is best for investors who prioritize income over long-term growth.
Market Capitalization
Market capitalization refers to the total Rand value of a company’s outstanding shares. Outstanding shares signify the shares of a company presently held by all its shareholders, including institutional investors’ share blocks as well as restricted shares owned by the officers of the company.
Market capitalisation=Outstanding shares x Share price
Therefore if a company has issued 1,000,000 shares and they are each valued at R20 then the market capitalization of the company is R20,000,000.
A common mistaken belief is that the share price indicates how big the company is. This is not necessarily true. For example, company A could have a higher share price of R100 per share in comparison to company B which has a share price of R20 per share, but company A may only have 1 million shares while company B has 10 million shares. In effect, company A would have a market value of R100 million while company B is valued at R200 million.
Market Capitalisation Categories
Market capitalization is a useful tool to determine which shares you are interested in, and how to diversify your portfolio with companies of different sizes.
investors look at the market in the following three categories most often since these are the market cap categories most stocks tend to fall into.
Investors look at the market in the following three categories most often since these are the market cap categories most stocks tend to fall into.
Large-cap companies
Large-cap stocks have market caps of more than R10 billion. Most of the best-known companies in the world are large caps, and these are typically the companies that have established themselves as the leaders in their industries. While many deals with the ups and downs of their industry’s cycles, these are often the strongest companies and have proven capable of holding off competitive threats.
Large caps are often where you’ll find the best dividend stocks. These large companies often generate more cash than they need for the business and return that extra capital to investors in dividend payments.
Investing in large-cap companies does not essentially give massive returns in a short period of time, but in the long-term, these companies could increase in share value and reward shareholders with dividend payments.
Examples of large-cap companies:
- Discovery
- Aspen Pharmacare
- Shoprite
MId-cap companies
Mid-cap stocks have market caps between R1 billion and R10 billion, occupying the middle ground between large and small companies. These are companies that are reputable and function in an industry projected to experience quick growth. Mid-cap companies are in the process of expanding.
They are attractive for their growth potential. Yet even with some track record, mid-caps also may face the daunting task of beating out, or even disrupting, bigger and better-funded large-cap competitors to realize their own financial promise.
Not all mid-caps are growth stocks. They may be companies that operate in a smaller niche without big growth prospects, or they may be former large caps that have declined due to changes in the competitive landscape or (as with many brick-and-mortar retailers) some industry disruption.
Examples of mid-cap companies:
- Clicks
- Barloworld
- Spar
Small-cap companies
The companies that are considered small-cap companies are those that are the next biggest after mid-cap companies. These companies are considered higher-risk investments due to the markets they serve and their size. Smaller companies with smaller share price values are riskier due to the spread, which represents the difference in the supply and demand of a share.
High demand for shares drives up the price of shares whereas a low demand drives down the price of shares. It is this difference that is shown by this spread. What makes this risky for small-cap companies with smaller share values is that even small shifts in share value can make a big difference in the overall value of the shares.
Small-cap stocks are more volatile than larger caps, meaning there is more risk of losses in the short term. These stocks are generally best owned as a diversified group, and for many years, in order to reduce those risks
Six types of stock to invest in
- Blue Chip
- Dividend
- Defensive
- Growth
- Cyclical
- Penny stocks
Blue Chip
Blue-chip stocks are large companies with strong brands, financially sound businesses and consistent earnings and cash flows. They also often pay sizable dividends. Blue-chip companies are typically leaders within their given market sectors and have successfully navigated economic downturns in the past.
Examples of Blue chip stock:
- Shoprite
Dividend shares
Dividend stocks are stocks that make regular distributions to their shareholders, usually in the form of cash payments. They can be useful sources of income, but the best dividend stocks can also be excellent ways to increase your wealth over the long term.
It is important to note that not all companies pay dividends, even if they are profitable.
Examples of dividend stocks
- Coca-Cola
- MTN
Defensive shares
Defensive stocks are shares that tend to perform relatively the same regardless of the overall economic conditions in a country. In other words, they defend the investor’s money in spite of a recession. Defensive stocks don’t mirror the overall cycles of the economy as much as cyclical stocks, they are also known as non-cyclical stocks.
Examples of defensive stocks:
- McDonald’s
- Pick ‘n Pay
Growth stock
Is a stock of a company that’s expected to increase its profits or revenues faster than the average business in its industry or the market broad. These stocks usually have a high price to earnings (PE) ratio, indicating that they are overvalued. This is because stock investors in a high growth rate that is expected of the company.
They do not pay high dividends instead, as the company grows investors receive higher capital gains on the increased value of the stock.
Examples of growth stocks:
- Purple Group
- Tesla
Value stocks
Value stocks are shares that are trading below their intrinsic value and are, therefore, considered good picks. They have a low PE and a low price to book value (PBV) ratio. Such stocks are also good dividend payers and have a healthy dividend yield. Value stocks could be from slow-growing industries or from companies that are facing some problems which lead to a fall in their stock price.
Example of value stocks:
- Shoprite
- Walmart
Cyclical stocks
A cyclical stock is one that will rise and fall in tandem with the economy. When the economy is strong, unemployment is low and both production and consumer spending is high, cyclical stocks tend to gain in value. But when a weakening economy hits – causing businesses to contract and lay workers off, and people to shut their wallets – the value of these stocks goes down.
Example of cyclical stocks:
- Apple
Penny stocks
Penny stocks refer to company shares that cost, if not merely a penny, a pretty low amount. In South Africa penny stocks are shares trading below R10 and in the use trade for less than $5 per share. Penny stocks are usually issued by new or very small companies. These companies often don’t have the kind of track record that generates investor interest, which is why their shares are sold for so little.
Larger, more established companies may also have stocks trading under R10 when facing financial trouble or approaching bankruptcy.
Examples of penny stocks:
- PPC
- Purple Group
When buying stocks you need to understand your risk appetite and have a diversified portfolio. In this article, we covered the bases of the types of stocks to invest in. There are other types of stocks you need to educate yourself with. We just covered the basics.
