Eight Categories of Stocks and What They Mean to Investors
Stocks can also be classified according to a number of other criteria, including company size and company sector.
Large Cap, Mid Cap and Small Cap
Stocks can be classified according to the market capitalization of the company. The market capitalization of a company represents the total dollar value of the company's outstanding shares. This is equal to the current market price of its stock multiplied by the number of shares of stock that it has outstanding. That number gives you the market value of the company, which is one measure of the company's size. Roughly speaking, there are three basic categories of market capitalization: large cap, mid cap, and small cap (although some analysts include others such as mega cap at the large end and micro cap at the small end).
The definitions for each of these might vary somewhat depending on whom you're talking to, but usually they are as follows:
- Large cap: market cap valued at more than $10 billion
- Mid cap: market cap valued between $1 billion and $10 billion
- Small cap: market cap valued at less than $1 billion
In general, the larger the cap size, the more established the company, and the more stable the price of its stock. Small cap and mid cap companies usually have a higher potential for future growth than large cap companies, but their stock tends to fluctuate more in price.
A penny stock is a stock priced under one dollar per share (or in some cases, under five dollars per share). Most penny stocks have only a few million dollars in net tangible assets and have a short operating history. Penny stocks are almost always small cap stocks, but the reverse isn't necessarily true. The term "penny stock" is sometimes used in a derogatory fashion, since many penny stocks are virtually worthless and should be considered extremely high-risk investments. There are also many cases of fraud involving penny stocks each year . We recommend that beginners steer clear of penny stocks.
Stocks are often grouped into different sectors depending upon the company's business. Standard & Poor's breaks the market into 11 different sectors. Two of these sectors, utilities and consumer staples, are said to be defensive sectors, while the rest tend to be more cyclical in nature . The other nine sectors are: transportation, technology, health care, financial, energy, consumer cyclicals, basic materials, capital goods, and communications services. Of course, other groups break up the market into different sector categorizations, and sometimes break them down further into subsectors.
Stocks can be classified according to how they react to business cycles. Cyclical stocks are stocks of companies whose profits move up and down according to the business cycle. Cyclical companies tend to make products or provide services that are in lower demand during downturns in the economy and higher demand during upswings. The automobile, steel, and housing industries are all examples of cyclical businesses.
Defensive stocks are the opposite of cyclical stocks: they tend to do well during poor economic conditions. They are issued by companies whose products and services enjoy a steady demand. Food and utilities stocks are defensive stocks since people typically do not cut back on their food or electricity consumption during a downturn in the economy. But although defensive stocks tend to hold up well during economic downturns, their performance during upswings in the economy tends to be lackluster compared to that of cyclical stocks.
A tracking stock is a type of common stock that is tied to the performance of a specific subsidiary of the company. This means that the dividends and the capital gains for the stock depend upon the subsidiary rather than the company as a whole. Owning a tracking stock does not give the owner voting rights in the corporation, nor do owners of tracking stocks have a legal claim upon the general assets of the corporation. A company will sometimes issue a tracking stock when it has a very successful division that it feels is under appreciated by the market and not fully reflected in the company's stock price.