If you're new to the world of the sharemarket, you may not be aware of the distinction between “stocks” and “shares”. Often used interchangeably, particularly in American English, these terms actually mean different things – or rather they provide different levels of specificity about the same thing. Stock refers to an undefined proportion of ownership of any publicly traded company, while a share refers to one individual unit of a specific stock. So a person who owns shares in a particular business has stock in that business, while a person who owns stocks owns shares in multiple companies.
There are two main types of stocks, common and preferred. Beyond this classification, stocks can also be further categorised according to the company's market value, geographical location and a range of other factors. This blog explores some of the different kinds of stocks available, and the reasons why investors may choose some types over others.
Common stock is the most frequently issued type of shares, usually called ordinary shares. Each share entitles its owner to a unit of equity ownership of a company. Holders of common stock are accorded voting rights on certain company issues, usually at one vote per share, and may also be entitled to a portion of the company's annual earnings, paid out in the form of a dividend. However, these dividends are dependent on financial performance and are not guaranteed.
Preferred shares generally do not provide voting rights. Instead, preferred stockholders are typically guaranteed a fixed dividend payment, allocated as a priority over any dividend paid to owners of common stock. If the company goes out of business, assets are distributed to preferred stockholders before common stockholders. On the other hand, it's less common for preferred stock to rise in value since dividends are fixed. Another downside to preferred stocks is that some are issued with a call feature, allowing the business to “call in” the stock after a certain date, cancelling shares immediately and redeeming them from shareholders for a pre-set price.
As well as varying according to the rights and rewards they provide, stocks are frequently differentiated according to other criteria:
Stocks in companies in the same or similar lines of business are grouped into categories known as stock market sectors. The Global Industry Classification Standard (GICS) currently sets out eleven different sectors a stock can belong to: energy, materials, industrials, utilities, information technology, healthcare, financials, consumer discretionary, consumer staples, communication services and real estate. Investors can opt to use what's called a “sector fund” to invest only in businesses that operate in a chosen area or diversify by spreading their investments across various industries.
Stocks are also categorised by geographical location, usually according to the site of the company's official headquarters. Investors may choose to buy domestic stocks (stock in companies headquartered in the investor's home country), international stocks (stock in companies headquartered abroad), or create a portfolio with a combination of both. Though there can be huge growth potential in emerging markets overseas, international investing comes with its own set of risks, most notably currency risk. Selling shares held in a foreign currency can incur an FX risk should you wish to transfer the proceeds into another currency. CurrencyFair account holders can avoid unnecessary costs by exchanging money from the sale of vested shares into more than 20 currencies at exchange rates up to eight times cheaper than the banks.
A company's market capitalisation refers to the total value of its shares on the market, calculated by multiplying the number of its outstanding shares by the current price of a share. Stocks can be classified as large-cap (generally considered as market capitalisations above US$10 billion), mid-cap (market capitalisations between US$2 billion and US$10 billion), or small-cap (market capitalisation of between US$300 million and US$2 billion). Many stock market indexes, such as the S&P 500, are weighted by market capitalisation.
Large-cap stocks are perceived as safer investments since they provide ownership in well-established, market-leading companies which usually generate reliable returns. Small-cap and mid-cap stocks tend to be subject to more price volatility and are therefore considered riskier. The other side of that coin is that small-cap stocks, in particular, often belong to new-to-market companies whose future value may not yet have been recognised. These stocks therefore have the potential to bring high returns over time.
Company size and reputation
Taking their name from high-value poker chips, so-called blue-chip stocks are stocks in large, proven, often world-renowned companies – usually large-cap stocks. The most expensive stocks to buy, these are considered the highest quality and most reliable performers. Though they typically weather recessions better than others, it should be noted that blue-chip companies can still fail – an obvious example is Lehman Brothers, whose stock collapsed spectacularly during the financial crisis of 2008. Indexes like the S&P 500, the FTSE 100 and the New Europe Blue Chip Index track the performance of the world's blue-chip stocks.
At the other end of the spectrum, penny stocks consist of shares in small companies that trade for low prices – below £1 in the UK and below US$5 in America. These companies have a market capitalisation below that of small-cap companies and are often in their growth phase, with limited resources and unproven business models. Many fail, but because their shares are cheap, large returns can be made on a relatively small investment in one of the few that do succeed. Still, penny stocks are considered high-risk investments, subject to extreme price volatility and limited liquidity.
Increasingly, investors want to put their money in companies that align with their values, particularly when it comes to environmental sustainability. The rising importance of issues like climate change and social justice to consumers has led to a substantial growth in environmental, social and governance (ESG) investing. A study by NYU found a strong relationship between ESG and financial performance, and Fidelity International's report “Putting Sustainability to the Test” found that stocks at the top of their ESG rating scale consistently outperformed those with poorer ratings in 2020, showing the growing importance of these criteria to their clients.
In making the choice between different types of stock, consider the types of business you want to invest in, the rights and returns you're hoping to gain, how much capital you have and your risk tolerance, and let these decisions guide you on when, where and how much to invest.
Selling overseas shares? Exchange money from the sale of overseas shares at lower-margin FX rates with CurrencyFair.
- Photo by Mathieu Stern on Unsplash
Disclaimer: This article is for general information purposes only and does not take into account your personal circumstances. This is not investment advice or an inducement to trade. The information shared is for illustrative purposes only and may not reflect current prices or offers from CurrencyFair. Clients are solely responsible for determining whether trading or a particular transaction is suitable. We recommend you seek independent financial advice and ensure you fully understand the risks involved before trading. Leveraged trading is high risk and not suitable for all.