When share prices rise, everyone wants to know what share to buy. Investors are keen to be a part of the wealth creation process. Stock markets are engines of economic growth for a country. A vibrant stock market is essnetial for a country like India. There are multiple ways an investor could participate.
HOW ARE STOCKS CLASSIFIED?
Stocks can be classified into multiple categories on various parameters – size of the company, dividend payment, industry, risk, volatility, as well as fundamentals.
Stocks on the basis of ownership rules:
This is the most basic parameter for classifying stocks. In this case, the issuing company decides whether it will issue common, preferred or hybrid stocks.
Preferred & common stocks:
The key difference between common and preferred stocks is in the promised dividend payments. Preferred stocks promise investors that a fixed amount will be paid as dividends every year. A common stock does not come with this promise. For this reason, the price of a preferred stock is not as volatile as that of a common stock. Another key difference between a common stock and a preferred stock is that the latter enjoy greater priority when the company is distributing surplus money.
However, if the company is getting liquidated – its assets are being sold off to pay off investors, then the claims of preferred shareholders rank below that of the company’s creditors, and bond- or debenture-holders. Another distinction is that preferred shareholders may not have voting rights unlike holders of common stocks.
Hybrid stocks:
Some companies also issue hybrid stocks. These are often preferred shares that come with an option to be converted into a fixed number of common stocks at a specified time. These kinds of stocks are called ‘convertible preferred shares’. Since these are hybrid stocks, they may or may not have voting rights like common stocks.
Stocks with embedded-derivative options:
Some stocks come with an embedded derivative option. This means it could be ‘callable’ or ‘putable’. A ‘callable’ stock is one which has the option to be bought back by the company at a certain price or time. A ‘putable’ share gives the stockholder the option to sell it to the company at a prescribed time or price. These kinds of stocks are not commonly available.
Stocks on the basis of market capitalization:
Stocks are also classified on the basis of the market value of the total shareholding of a company. This is calculated using market capitalization, where you multiply the share price by the total number of issued shares. There are three kinds of stocks on the basis of market capitalization:
Small-cap stocks:
- ‘Cap’ is the short form of ‘Capitalization’. As the name suggests, these are stocks with the smallest values in the market. They often represent small-size companies. Generally companies that have a market capitalization in the range of up to Rs. 250 crore are small cap stocks.
- These stocks are the best option for an investor who wishes to generate significant gains in the long run; as long he does not require current dividends and can withstand price volatility. This is because small companies have the potential to grow rapidly in the future. So, an investor may profit by buying the stock when it is cheaply available in the company’s initial stage. However, many of these companies are relatively new. So, it is difficult to predict how they will perform in the market.
- Being small enterprises, growth spurts dramatically affect their values and revenues, sending prices soaring. On the other hand, the stocks of these companies tend to be volatile and may decline dramatically.
Mid-cap stocks:
- Mid-cap stocks are typically stocks of medium-sized companies. Generally, companies that have a market capitalization in the range of Rs. 250 crore and Rs. 4,000 crore are mid-cap stocks.
- These are stocks of well-known companies, recognized as seasoned players in the market. They offer you the twin advantages of acquiring stocks with good growth potential as well as the stability of a larger company.
- Mid-cap stocks also include baby blue chips – companies that show steady growth backed by a good track record. They are like blue-chip stocks (which are large-cap stocks), but lack their size. These stocks tend to grow well over the long term.
Large-cap stocks:
- Stocks of the largest companies in the market such as Tata, Reliance, ICICI are classified as large-cap stocks. They are often blue-chip firms.
- Being established enterprises, they have at their disposal large reserves of cash to exploit new business opportunities. However, the sheer size of large-cap stocks does not let them grow as rapidly as smaller capitalized companies and the smaller stocks tend to outperform them over time.
- Investors, however, gain the advantages of reaping relatively higher dividends compared to small- and mid-cap stocks, while also ensuring the long-term preservation of their capital.
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