Not all shares in the stock market are the same. To correctly compose an investment portfolio, you need to understand their difference. Do you want to receive stable dividends or are you interested in maximum profit after the planned investment horizon? Such issues, including the acceptable level of risk, affect the choice of types of shares and the ratio of their shares in the portfolio.
Dividend stocks
As the name implies, these are stocks that bring the investor a regular income. The frequency of payment is determined by the board of directors of a particular company. It can be, for example, quarterly or annual.
For some companies, the amount of payments is a fixed percentage of the profit received for the previous period, while others may determine the amount of dividends depending on plans for further development or even completely refuse to pay for a certain period.
Those companies that for more than 25 years not only consistently share profits with their shareholders, but also constantly increase the percentage allotted for dividends, are called dividend aristocrats. Of those who are always on the lips, these are IBM, Coca-Cola, Procter & Gamble, S&P Global, McDonald’s, Walmart, Realty Income, Dover, 3M and more than fifty others. Some of these companies have raised their dividends year after year for more than 60 years.
In most cases, dividend stocks grow in value more slowly than stocks of those companies that do not pay dividends, because part of the free capital is spent on payments to shareholders, and not on new projects.
When a large dividend is paid, it may indicate that the company is financially healthy and making good profits. However, high dividends can also indicate signs that the company is not planning further development and is not reinvesting available cash.
For companies with an established history of paying dividends, any significant reduction in the amount of payments or the complete elimination of dividends can be a warning about the financial health of the company. On the other hand, it may be a signal that management has a plan to reinvest this money into business growth. That’s why it’s important to research the companies you’re buying securities from and keep an eye on news from those issuers.
Stable dividends are cash flow that you can use as you wish, but more often than not, it is reinvested back into the stock market. Dividend stocks, especially those from dividend aristocrats, tend to be financially stronger, so investors can rightly expect securities to hold their value in the event of an economic downturn or quickly recover to their previous positions. This makes them preferred by investors with low risk appetite.
Ordinary stocks
Ordinary shares are the most liquid securities in the stock market for the simple reason that their number is greater than any other, and the interest in them is higher. Common stocks are also the main instrument of speculation for traders.
This type of shares does not promise any guaranteed income in the form of dividends, but allows you to take part in the affairs of the company. Basically it means voting. However, this rarely worries private investors, since their stake in the company is too small to use this opportunity.
Preference stocks
Preferred shares deprive the investor of the right to vote, but in return provide a fixed amount of payments in the form of dividends. It is spelled out in the charter of a joint-stock company in the form of a specific amount, a percentage of net profit or the par value of a share. In addition, holders of this type of securities receive any payments as a matter of priority. Including the division of property in the event of liquidation of the company.
It would seem that preferred shares are the best choice, but this is not always the case. The profitability of securities depends on the dividend policy and current affairs of the company. The issuer may demand back preferred shares from the shareholder without giving reasons (although the damage will be compensated). In addition, ordinary shares, as a rule, are more expensive than preferred shares due to greater liquidity.
You also need to understand that the possession of this type of paper does not at all guarantee uninterrupted payment. In the event of a loss, the company may grant you a one-off voting right in lieu of the planned dividend.
Growth stocks
Growth stocks are equity securities of companies that:
a) Growing faster than the market average
b) Have a clear potential for such growth
You will generally not receive dividends from these issuers for the foreseeable future, as all their profits will be reinvested back into the business, which will further increase the share price. If there are dividends, they will be very symbolic. In any case, growth stocks are bought not for the sake of regular payments, but in order to fix the maximum profit in the future.
Of course, no one guarantees that the uptrend will continue. But it should be obvious that higher returns go hand in hand with higher risk.
Value stocks
Value investing involves looking for companies that are undervalued in terms of their key metrics and are trading below their peers in the industry.
“Discounts” on the securities of these issuers can be caused by various factors, for example, bad news, after which there was an outflow of investors, which, of course, provoked a decrease in the market price. But these factors may not affect the profitability and prospects of the company at all.
Value stocks in areas such as finance, natural resources, or energy tend to perform better during economic recovery periods.
Blue chip stocks
Blue chip stocks are common stocks of the largest established large-cap companies that have the most liquidity in the stock market. They are also called first-tier stocks.
These issuers make up the bulk of the indexes and are considered reliable enough to invest in. Traditionally, these papers occupy the bulk of the portfolio, especially during periods of uncertainty.
Defensive stocks
This type of securities is used during periods of bear markets (recession). Defensive shares are held by companies that provide basic products and services that people need regardless of the economic situation (health care, food, etc.).
Due to the demand for these services and products by the consumer, defensive promotions have less volatility and are more predictable. Some blue chips from the respective sectors can certainly be included in this group.
Penny stocks
These are extremely cheap securities of small companies. Most often they are traded on the OTC market, although some can be found at large brokers.
These stocks are mostly speculative and therefore subject to high volatility and high risk. Their liquidity is very low, so it can be difficult to get rid of them in time. This is not the area of conservative and, especially, novice investors.
IPO stocks
Until a company issues its securities, it is considered private. When a company decides to go public, it announces an initial public offering (IPO) to institutional and general investors.
IPO shares are offered at a discount before these securities are listed on the stock exchange. This makes it possible to accelerate the receipt of capital and reduce risks. To avoid speculative actions, investors cannot sell IPO shares they bought at a discount immediately after the shares start trading.