Selecting your own stocks can be hard work. The exciting thing is that the Internet has much of the information you need, and most of this information is free. With the power of your computer, you can utilize Internet data to gain real insight. As you start to determine which stocks you’re interested in, you should be aware of the different types of stocks. Stocks have distinct characteristics, and as general economic conditions change, they behave in special ways.
Write a short list of your financial goals and then investigate how different types of stocks relate to those objectives. Different stocks have different rates of return — some are better for young, aggressive investors; others are better for retirees or for people in high tax brackets. Here are a few examples of the different types of stocks that may match your investor objectives:
- Blue-chip stocks: Usually the most prestigious stocks on Wall Street, these high-quality stocks have a long history of earnings and dividend payments. These stocks are often good long-term investments.
- Cyclical stocks: The fortunes of these companies rise when business conditions are good. When business conditions deteriorate, their earnings and stock prices decline. These companies are likely to be manufacturers of automobiles, steel, cement, and machine tools.
- Seasonal stocks: Similar to cyclical stocks, these companies’ fortunes change with the seasons. Good examples of seasonal companies are retail corporations whose sales and profits increase at Christmastime.
- Defensive stocks: These stocks tend to be stable and relatively safe in declining markets. Defensive stocks are from companies that provide necessary services, such as electricity and gas, which everyone needs regardless of the economic climate. Companies in this category also provide essentials such as drugs and food, so their sales remain stable when the economy is depressed. (Note: Defensive stocks are not related to the military.)
- Growth stocks: Growth companies are positioned for future growth and capital appreciation. However, their market price can change rapidly. Rather than pay dividends, growth companies typically spend their profits on research and development to fuel future growth. These stocks are good for aggressive, long-term investors who are willing to bet on the future. If you’re in a high tax bracket, these stocks may be for you; low dividends mean fewer taxes. But if expected earnings don’t match analyst predictions, expect a big decline in stock price.
- Income stocks: Purchased for their regular, high dividends, income stocks usually pay bigger dividends than their peers do. Income stocks are attractive to retirees who depend on their dividends for monthly expenses. Income stocks are often utilities companies and similar firms that pay higher dividends than comparable companies. These companies are often slow to expand because they spend most of their cash on dividend payouts. During times of declining interest rates, bonds are better investments.
- International stocks: Investors in these stocks often believe that U.S. domestic stocks are overpriced. These investors are seeking bargains overseas. However, international stocks include some risks that U.S. stocks don’t have, such as trading in another currency, operating in a different economy, being subject to a different government, and using accounting standards that don’t follow U.S. generally accepted accounting principles. Public information may have to be translated, which causes delays and sometimes miscommunication. All these elements add cost and risk to foreign stocks.
- Speculative stocks and initial public offerings: Speculative stocks are easy to identify because they have price/earnings (P/E) ratios that are frequently twice as high as other stocks. For example, the S & P 500 Index has a median P/E ratio of 23.2. Speculative companies have a high probability of failure. However, if they succeed, the returns can be very large. A speculative stock could have a P/E ratio of more than 75, in an industry with an average P/E ratio of 50. A second type of speculative stock is an initial public offering (IPO). This type of stock often has no track record. A good example of speculative stock is Taser; (TASR) its stock price is relatively high, and its revenues are small.
- Value stocks: Some Wall Street analysts consider these stocks to be bargains. These stocks have sound financial statements and earning increases, but are priced less than stocks of similar companies in the same industry.