Everyone wants to create wealth. Stock market is a great place for long term wealth creation .Though stocks are risky, they can offer lucrative returns if decisions of investments are made with reasonable care. Understanding the basics of stock investments such as what are the different types of stocks, how to choose them, etc. can help you manage risk and succeed in stock market investing.
Stocks are classified on various criteria. Let’s take a look at some common types of stocks along with tips to choose them.
Based on ownership rights
✓ Common stocks: Such stocks come with voting rights. However, common stocks are the lowest in priority in the event of company’s liquidation. Therefore, common stockholders do not get their money back until the preferred stockholders and bondholders get their respective shares. However, common stocks usually perform better than preferred stocks and bonds and so there is a possible upswing in the longer run.
✓ Preferred stocks: These stocks pay regular dividends to the investors, which is either fixed or set against a benchmark performance. They are also less volatile than common stocks.
Tips to choose: Common stocks are easier to trade on the stock exchange. Also, preferred stocks are offered under private placement where retail investors can hardly participate. Since large corporates buy preferred stocks, it is a common way to raise money. Some companies also offer convertible preferred stocks that can be exchanged with common stocks after a point of time. So, even though preferred stock is equity, it works a lot like bonds and can behave like debt from a tax angle.
Based on market capitalization
✓ Large-cap stocks: These are stocks of well-established companies with a large market capitalization. These companies usually have a valuation of Rs 10,000 crore or more.
The large cap or blue-chip stocks, as they are commonly known as, are of large financially sound companies with a steady growth rate. However, they generally do not provide tremendous growth in a short span of time. They usually provide steady growth in the longer run. Some common examples of blue-chip stocks in India are SBI, Bharti Airtel, HDFC Bank, TCS, Infosys, Wipro, ONGC, ITC, Maruti Suzuki, Kotak Mahindra Bank, etc.
✓ Mid-cap stocks: These are stocks of companies that have a market capitalization of Rs 500 crore to 10,000 crore. These stocks are however more volatile than large cap stocks and are preferred by intraday traders than long-term investors. Some examples of mid-cap stocks would be Bata India, Colgate-Palmolive, Emami Ltd., Berger Paints, Canara Bank, Godrej Industries, etc.
✓ Small-cap stocks: These are stocks of companies that have a market capitalization of less than Rs 500 crore. These are highly risky in nature. Foretelling the fortunes of these stocks is notoriously difficult as the price movements can be volatile. These stocks are usually preferred by intraday traders who use technical analysis to pick the right stocks. They do so in the hope of making a quick buck over a single day. Some popular small cap stocks are Pfizer Ltd., Spice Jet Limited, L&T Technology Services Ltd., Fortis Healthcare, etc.
Tips to choose: You need to know which stocks would work best for you. If you are looking for a steady portfolio which does not need to be actively managed, then you can opt for large-cap stocks. If you want high growth along with some stability in the portfolio, then mid-cap stocks are a good buy. And if you are an aggressive investor with sufficient market knowledge, small-cap funds would be a good bet, provided you have done the basic groundwork on the company and the management before investing!
Based on price trends
✓ Defensive stocks: Such company stocks are unaffected by market conditions. For example, stocks of pharma companies, insurance, tobacco, food and beverage companies etc. perform moderately in all market scenarios.
✓ Cyclical stocks: Such stocks get affected more by market cycles and trends and have a particular cycle of operation. For example, stocks of travel companies, automobiles, airlines and hotels etc. are cyclical in nature.
Tips to choose: Defensive stocks are preferable during tough market conditions and cyclical stocks can be an option during a booming market. Cyclical stocks are more market sensitive and choosing them at the right time of the cycle is more important.
Based on investing style
✓ Value stocks: These stocks have some potential but are undervalued compared to their peers. The stock could be underpriced due to multiple reasons like change in management, cyclical, financial distress, investor sentiments, etc.
✓ Growth stocks: Such stocks are in the midst of a growth phase. Price of such shares rise faster as companies ideally reinvest their earnings instead of distributing dividend.
✓ Income stocks: Usually these are the stocks of stable companies who distribute higher dividend and thus provide some stability to the investors.
Tips to choose: ‘Buy low, sell high’ is the common philosophy followed for value stock.
Growth stocks are best for aggressive investors who are primarily looking for capital gains.
Income stocks are relatively less risky can be a secondary source of income. However, these stock prices may witness a huge fall during market downturn.
To conclude, it’s important to choose the stock that fits your investment profile. There are lots of factors that need to be considered like market conditions, company fundamentals, tax implications, volatility, etc. that goes into the process of stock picking. Knowing the basics can help you make the right and informed choice. You can also seek help of financial advisers with regard to strategies, individual stock selection and key investment decisions.
Disclaimer: Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.