Every investor is unique, as each one has a different risk profile and a varied investing style. Think of it like sports. Some people like basketball, where a team has to try and score every 24 seconds, while others like golf, where one can take their own time.
Others may like baseball, where an average nine-inning game can go on for over three hours, and some people like boxing, which can get over in less than 10 seconds. Events like the Super Bowl take place every year, while some, like the Olympics, are organized once every four years.
Some people stick to one sport, while others watch all of them depending on the season and what catches their fancy at a particular point. Stocks are like that. There are different categories of stocks, and investors can choose to invest in any of them depending on the situation and the financial goals they have. Here’s how stocks are categorized:
According to market cap
Market cap or capitalization is calculated when you multiply the share price of a company by the total number of issued shares. Essentially, market cap determines the size of a company:
Small-cap: These are companies with a market cap between $300 million to $2 billion. These are small companies that have plenty of room for aggressive growth. Imagine if you had an opportunity to invest in Facebook in 2007-08. Hardly anyone knew that a company born in a college dorm would dominate the world.
Small cap firms could be start-ups, or they could be companies that have been around for some time but haven’t grown in size. However, these companies are just as likely to fail as they are to succeed. Growth spurts in their stock prices could give one’s portfolio a massive boost, while price volatility could bring it crashing down. Investing in small-cap companies is suitable for high-risk investors.
To give you a sports analogy, this is equivalent to investing money in a promising college athlete. The athlete dominates college, but they are still unknown in the pro world. They could shine, or they could sink.
Mid-cap: These are companies with a market cap between $2 billion to $10 billion. These are companies that have been around for some time. To compare it with sports: These are players who are known for their playing style.
You know that they have the potential to turn into stars, and they are also stable enough that you don’t have to worry about them burning out. They are emerging stars. Think of Michael Jordan in the 1980s. There was something about him that stood out, but everyone knew that he would shine. These kinds of stocks have solid growth potential and the stability of a larger company.
Large-cap: These are the superstars of the investing world. They are worth a minimum of $10 billion, and some of them are even mega-caps worth over a trillion dollars. Think of Kobe Bryant in basketball or Roger Federer and Serena Williams in tennis, or Tom Brady in football. You know that you can rely on these players to deliver day in and day out.
A bet on these players in their heydays would rarely go wrong. However, your betting odds here are never extravagant. It’s the same with large-cap stocks. Investors will make a decent amount of money, but the potential for upside is limited in the short term. Moreover, you have to keep in mind that these companies have huge cash reserves, and they spend a lot on innovation. Think Microsoft, Apple, Facebook, and Alphabet.
By dividend yield
A dividend is a share of profits that a company pays out to its shareholders.
Income stocks: There are some stocks that pay out dividends to their shareholders regularly. Generally, these are companies that have consistent and predictable revenues. They have defined profit margins, and they know exactly how much they can pay out.
Companies like Coca-Cola, Colgate-Palmolive, and Johnson & Johnson have been increasing their dividend payout for almost 60 years. And it is likely they will continue to do so. These stocks are great options for retirees who want a steady source of passive income.
On the basis of fundamentals:
Value stocks: These are stocks that are undervalued, as in they should be worth a lot more, but they aren’t. Remember the movie Moneyball? Brad Pitt played Billy Beane, the general manager of the Oakland Athletics, a baseball team made up of a lot of undervalued players who won the American League West title. Those are value stocks. They have the potential and are on the cusp of something great, but the outside world doesn’t know it.
Cyclical stocks: Would you ever bet against Rafael Nadal at the French Open between 2005 and 2020? The man won 13 out of 16 titles in Paris. Nadal at the French Open is the perfect example of a cyclical stock.
Such a stock rises and falls with the economy. Examples of cyclical stocks are airline companies like SouthWest or sporting goods companies like Nike, and coffee companies like Starbucks. When the economy is down, these stocks don’t do great, but they surge when the overall environment is great.
Growth stocks: These are companies that don’t pay out any dividends. They take all the money they have and invest it into the business. They want to grow at a faster rate. Investors who buy stock in these companies are betting on the long-term potential of these companies. Example: Facebook and Amazon.
Defensive stocks: These are the exact opposites of cyclical stocks. They will continue to do well in any environment, but it is unlikely that they will ever outperform. Example: Campbell Soup or Colgate-Palmolive. Income stocks are generally defensive stocks. They hold steady in good and bad economic times.
By sector breakdown
Sectoral investing: Do you know people who live and die on one sport? They know everything there is to know about it, player statistics, home advantage, and win-loss records going back 50 years. These are sectoral experts.
Sectoral investing is where people focus on one sector and invest or withdraw their money in it. Ideally, a good sectoral investor will invest in as many sectors as possible to reduce risk in case something impacts their particular sector. Sectors include financials, technology, consumer staples, and energy, among others.