The Stock Market is the largest and most comprehensive in India. It provides an integrated platform to buy and sell shares, derivatives, mutual funds, and structured products. The platform is built around a centralized equity trading system that facilitates trading between the public and private markets.
Stocks are another way for you to invest in the financial market. There are several different types of stocks. These stocks can be categorized into different classes based on their fundamental set of characteristics like class and ownership.
While this is the fundamental concept of stocks, as an investor, you need to know about the different categories of stocks to make informed decisions. Stocks can be categorized based on several parameters like class, ownership, market capitalization, dividend payout, etc.
Classification of Different Types Of Stocks
1) Categorization Criteria: Market Capitalization
Market capitalization is a way to classify stocks based on their size. Large-cap stocks are generally more valuable than mid-cap or small-cap stocks, and therefore command a higher price.
The classification of stocks is based on their market capitalization (market cap). A stock's market cap is a measure of the total value of its outstanding shares.
- Large-cap: The top 100 companies in terms of market capitalization. These are the market stalwarts and famous brand names. They also tend to pay good dividends to their shareholders.
These companies generally have large market caps and are often considered to be more stable and less risky than mid-cap and small-cap stocks. They are also considered to be more mature compared to other stocks because their performance has been more consistent over time.
- Mid-cap: Those ranking between 101 and 250 in the list of companies as per market capitalization. These are growing companies that have been around for some time and with a sizable customer base.
Mid-cap companies tend to have higher growth rates, but they're also more sensitive to economic cycles and industry trends, so they can be less predictable than large-cap stocks.
- Small-cap: All the remaining companies. The major chunk of the market consists of small-cap companies.
While some of them offer huge growth potential, others fail to survive the economic volatility. Small-cap stocks tend to have higher volatility than the other two categories because they're lower on the totem pole when it comes to size and liquidity.
2) Categorization Criteria: Ownership
Stocks are classified according to their ownership. Preferred stocks offer a higher dividend, while common and hybrid stocks do not.
The classification of a stock depends on its rights and privileges: the preferred stock has more rights than common stock, while hybrid stocks have all the rights of common stock and none of the privileges.
- Common Stock – It offers ownership in the company with voting rights to elect the board of directors.
Stockholders having common stocks are eligible to receive a part of the company’s profits via dividends. These are the most common types of stock in India.
- Preferred Stock – It also offers ownership in the company but doesn’t come with the same voting rights as common stocks. These stocks receive promised dividends that are not available with common stocks.
Also, if the company liquidates, then these stocks get preference over common stocks.
- Hybrid Stocks - Hybrid stocks combine features from both preferred and common stocks. The most common type is the convertible bond which allows investors to convert their bonds into equity or debt.
- Convertible Preference Shares – These are initially issued as preference stocks that are converted into a fixed number of common stocks at a specific time. The company can decide whether to offer voting rights with these stocks or not.
- Stocks With Embedded Derivative Options – Once a company issues shares, it usually doesn’t buy them back unless it deems fit.
However, some companies issue stocks with embedded derivative options – call-able or put-able.
In a call-able option, the company can buy back its stocks at a specific price or a specific time.
In the put-able option, the company can provide the investor with an option to sell the stock back to the company at a specific price or a specific time. These are not commonly issued by companies.
3) Categorization Criteria: Fundamentals
While the market price of a stock depends on the demand and supply of the said stock in the market, most investors assess the financials of the company before buying its stock.
Understanding the intrinsic value helps determine how much the market price deviates from the true value of the price of a share in the said company. Based on fundamentals, there are two types of stocks:
- Overvalued Stocks – These are stocks that have a market price that cannot be justified by their earnings outlook. Hence, the market price of such stocks is higher than their intrinsic value.
- Undervalued Stocks – These stocks have a market price lower than their intrinsic value.
4) Categorization Criteria – Price Volatility
While some investors thrive on price volatility, others prefer relatively stable stocks. Based on price volatility, stocks can be classified into the following two types:
- Beta Stocks – Investment analysts use a statistical measure called the coefficient of beta to find the volatility in stock prices. If a stock has a higher beta, it means that the investment risk is higher.
- Blue-chip Stocks – These are the most stable stocks since the companies are well established. Some examples are companies like Reliance Industries, Infosys, etc.
5) Categorization Criteria – Profit Sharing
When you purchase a stock, you become a shareholder in the company and are eligible to receive a share of the profits based on the amount invested. Usually, companies share profits with their shareholders in the form of dividends.
A company can either share profits by directly distributing dividends to its shareholders or invest its profits to improve and grow its business. Based on how the company shares its profits, you get two categories of stocks:
- Income Stocks – These stocks offer consistent dividend payouts. They are called income stocks since they can add to the income of the shareholder.
These stocks usually belong to companies that have strong finances and can share dividends from their profits every year. However, since the profits are distributed, these companies grow at a steady pace and are considered low-risk investments.
- Growth Stocks – These stocks don’t pay dividends. Instead, the company reinvests its profits to grow its business. Such companies aggressively seek growth and the prices of their stocks grow rapidly. This offers the stockholder an opportunity to earn profit by selling the stocks and making capital gains.
These are considered riskier than income stocks since the profits are based on the market price that can fluctuate for reasons beyond the control of the company.
6) Categorization Criteria – Economic Trends
When the stock markets react to some news about the economy, all stocks don’t move in tandem. While a certain section falls with negative news about the economy, another section seems unperturbed. Based on the way stocks react to economic trends, they can be categorized into two types:
- Cyclical stocks – These stocks move in sync with the economy. Hence, when the economic trends are negative, the prices of these stocks drop and vice versa. Investing in such stocks is usually beneficial in a booming economy.
- Defensive stocks – These stocks don’t react strongly to economic trends. Some examples of such stocks are food, medicines, insurance, etc. These are considered safer to invest in.
Understanding the different types of stocks can help you choose the right stocks to help you meet your financial goals. So, once you have an investment plan in place, use this knowledge to select stocks that are in sync with your plan.
Remember, successfully investing is about managing risks efficiently while trying to optimize returns. With sufficient knowledge, you can make informed decisions and see your wealth grow. Create a category-wise stock list to help you make decisions in the future.
Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.