Investors commonly classify common shares according to the characteristics and expected performance of the company. Some of the more common classifications are reviewed in this article.
Income Stocks
Income stocks are shares of companies that have a relatively stable growth in sales, earnings, and dividends. The return to the shareholder, in the form of dividends, is higher than the average current return in the market. Income stocks are considered safe investments, although growth prospects are lower than they are for riskier stocks. Sales of companies that are considered income stocks are usually related to the expansion of the population or other demographic factors rather than to business cycles.
Cyclical stocks
Cyclical stocks are those of companies that have variable fortunes, depending on the trend of the business cycle. Their sales and earnings outperform those of a lot of companies in a strong, expanding economy. However, during a downturn in business conditions, company sales and earnings will usually deteriorate to a greater degree. The reason for these extreme fluctuations is that cyclical companies sell products include cars, machinery, construction materials and cement. The purchase of other products, such as food and essential services, cannot be postponed to late dates.
Growth Stocks
Growth stocks are those of companies that have above-average prospects. Sales, earnings, and return on equity are expected to increase at a rate greater than both the economy and the industry in which the company is classified. The expected growth may be related to such fundamentals as new products or improved technology. Earnings are usually retained to finance continued growth, and as a result dividend payments are small. A growth stock can appear in any industry. A company with good growth potential can be a mature one with a good track record or a newer firm with widespread appeal.
Speculative stocks
Speculative stocks are those of companies with a highly erratic earnings record. Such a company might be a newly established oil, gas, or mining company with no tangible assets. Or it could be a company with an untried product and seemingly great potential. A large element of risk is involved in investing in speculative stocks. Stability, income, and safety are traded against the chance of capital appreciation. Some speculative stocks do very well, and eventually become well-established companies. These cases are very rewarding to the faithful investor, but they are the exception.
Other common classifications
Beyond the four general classifications listed above, there are a number of other common terms used to classify shares. Shares in companies with large financial resources, a well-established earnings record, and a dominant position in its industry are considered high quality or blue chip investments.
Performance or concept stocks are those that are the popular favorite of the day. They may be in any one of the four classifications listed above, but have special status due to market mood and current fads in buyer behavior. One of the dangers of performance or concept stocks is that they are sometimes bid up in price to an unreasonable level and then lose their appeal. There usually follows a drop in share price as a premium price is no longer justified.
Defensive stocks are shares in companies that are expected to be less affected by a downturn in the business cycle than other companies. Utilities are often cited as good defensive stocks because their earnings and dividends are more stable in downturns than those of cyclical stocks.
Other common terms used are junior industrials, which are small, established, and stable industrial companies; and glamor stocks, which are usually growth stocks that sell at high prices relative to current earnings.
