Stock usually refers to the securities of a publicly traded company that give the holders partial ownership of a business’s profits and assets—its equity. Companies sell stock, in the form of shares, to investors as one way of raising capital, which can be used to purchase assets, expand the business, or acquire another company.
After the company sells the shares, typically in a process called a public offering, they can be traded through regulated exchanges. Most investors buy shares this way, rather than from a company in an initial public offering (IPO) or a secondary.
The main incentives for investors to own a company’s shares are a rising stock price, as a consequence of increased profits, and income in the form of dividend payments.
How to classify stock issued by companies
Companies usually categorize stock in one of two general ways.
The name stems from the ownership of a common interest in a company and its profits. Holders of common shares are entitled to vote on company matters, including election of the board of directors, which represents the shareholders and is responsible for hiring and supervising the company’s top executives.
Some companies have dual classes of common stock, with one class having greater voting rights than the other. Typically, the class with greater voting rights is held by company founders and insiders, to ensure they don’t lose control of the company. Alphabet (formerly Google), Meta Platforms (formerly Facebook), and Berkshire Hathaway are among the companies with dual classes.
Holders of these shares get preferred dividend treatment—the company must pay dividends on these shares before any are paid on common stock. Preferred stockholders also stand in line ahead of common shareholders for claims against the company if it declares bankruptcy or dissolves. The trade-off is that preferred shares don’t enjoy any gain in value from the company’s increased profits. Investors often view preferred shares more like debt or other company obligations rather than as equity.
Stock types based on investors’ criteria
While companies offer stock in only two types, common and preferred, investors can use other criteria for classifying stocks:
Investors may assess stocks based on the market capitalization of the companies. Market cap, or market value, is the total number of a company’s shares outstanding multiplied by the current stock price. Ranking of market caps by size is used to create indexes, such as the Standard & Poor’s 500, that serve as performance benchmarks for individual stocks.
Companies tend to fall into one of three market-cap sub-categories:
- Large-cap. These companies usually have a market cap of $10 billion or more, although some companies such as Apple, Microsoft, and Amazon have market caps exceeding $1 trillion and are sometimes called mega-caps. Large-cap stocks are usually regarded as safer, conservative investments, because the companies often have established dominant positions in their industries and are in the later stages of their growth phase. Most pay dividends, providing investors with income and a stock price that rises with increasing earnings.
- Mid-cap. Companies in the $2 billion to $10 billion market-cap range generally are considered mid-cap stocks, and include car retailer AutoNation and video-game retailer Gamestop. They may still be in the middle of their growth curve, with room for further expansion and market-share gains in their respective industries, but not necessarily. They may be less volatile than small-cap stocks, but also have less potential for big price increases.
- Small-cap. These companies typically have market caps of $300 million to $2 billion. Some are startups or early-stage companies in fields such as biotechnology research and development, but many actually have established profitable businesses. Because they are small, such companies sometimes have greater potential for growth, but their shares tend to have bigger price swings than large- or mid-cap stocks. Examples of small-cap stocks include Emergent Biosolutions Inc., a developer of vaccines and antibody treatments, and WD-40 Co., maker of the name-brand lubricant.
7 other ways to classify stocks
There are a number of additional ways to categorize stocks, including:
Income or dividend
Stocks of companies that pay steady dividends can be attractive to investors who want a reliable source of income and are less concerned about capital appreciation.
Investors focused on income stocks will often compare the dividend yield, which is the amount of a company’s dividend expressed as a percentage of the stock price. Utilities, energy and natural-resources companies, and real estate investment trusts generally have higher dividend yields.
Growth companies typically are expanding and reinvesting any earnings back into operations, paying no dividends. Investors are focused on capital appreciation, anticipating big gains in the share price when a company becomes a success. But until the time when profits take off, growth stocks often seem to be overvalued and speculative. For this reason, their stock price can be highly volatile.
These companies are often characterized as undervalued relative to their ability to generate earnings and cash flow. Value investors such as Warren Buffett are betting that the shares of these companies will eventually climb as other investors start to recognize their value and bid up the price. Value stocks tend to be less volatile, with less price appreciation than growth stocks. But because they also tend to generate a lot of cash, most of them pay dividends.
Industry or sector
Sectors are broad classifications that can include several different industries. The financial sector, for example, encompasses the banking, insurance, securities brokerage, and mortgage industries.
Stock markets in the U.S. currently use 11 different broad sector classifications. Investors might choose to focus on sectors that have more promising growth prospects than others—the technology sector over the industrial sector, for instance.
Cyclical stocks generally are in industries whose fortunes rise and fall with the cycles of the economy. Share prices of cyclical companies increase when the economy is expanding and demand for their products is high, and vice versa during economic slumps. Examples of cyclical industries include automakers and appliance manufacturers, as well as travel companies and luxury-goods makers.
Sometimes called defensive stocks, these are shares of companies that tend to ride through the business cycle as demand for their products and services holds steady because consumers need them regardless of the state of the economy. Supermarket chains, makers of household products, and utilities are some examples of non-cyclical industries.
Domestic, international, and emerging markets
Investors may evaluate stocks based on the location of the companies, and buy shares of non-U.S. companies as a way of diversifying.
Investing outside the U.S. may offer some potentially higher returns, but it entails risks, starting with currency fluctuations in the dollar’s exchange rate when paying for stocks in another currency.
International stocks generally are regarded as those of companies based in western Europe, Canada, Japan, Australia, and New Zealand. These so-called developed markets have well-established economic and market systems and regulations, and offer open access to foreign investors.
Emerging-market stocks are in companies based in Asia, Africa, and Latin America. The countries are characterized as emerging markets because their economic and financial infrastructures are still developing, they may have some political instability, and they have varying taxation and restrictions on foreign investment. The biggest emerging markets are China, Brazil, India, and Russia, a group sometimes referred to as the BRICs.
Stocks vs. other types of securities
Investors with different goals and varying risk-reward tolerance sometimes consider other types of securities or financial instruments including:
- Bonds. Companies can sell bonds as well as stock to raise capital. But unlike stockholders, who are partial owners of the company, bondholders are creditors. They receive interest payments before any dividends are paid to shareholders. They also come before shareholders in claiming company assets in a reorganization or bankruptcy. Bonds are safer in this respect, but they can’t appreciate in market value like stocks, and inflation erodes the value of the interest payments as well as the principal, or the borrowed money the company must eventually pay back to investors.
- Commodities. Direct investment in commodities such as wheat, oil, or gold requires more money than stocks, and it requires storage—facilities to keep the commodities. Directly buying commodities is generally not feasible for small investors. Futures contracts, as well as commodity funds (mutual funds or ETFs) can give investors indirect access to an array of commodities.
- Currencies. Foreign-exchange is almost exclusively for professional traders, but small investors can buy bank certificates of deposit denominated in foreign currencies, as well as foreign-bond funds and ETFs that focus on currencies. Stocks of multinational companies such as Coca-Cola and McDonald’s also give investors an indirect interest in other currencies because so much of their profits come from overseas sales.
- Derivatives. These are securities or financial contracts whose value is based, or derived, from the value of some other security or asset. Stock options, for example, allow investors to either speculate on stock prices or hedge existing stock investments, at relatively lower cost than buying stock outright. Futures contracts on stock indexes can similarly be used to speculate or hedge.
- Funds. Mutual funds and index funds are the most common way many investors own stocks, through the weighted baskets of stocks in the indexes and the portfolio composition of the mutual funds. These provide instant stock market diversification at a lower cost.
The bottom line
Companies sell stock as a way to raise capital, giving investors a partial ownership stake—or share—in the business. Common shares offer greater potential returns than preferred shares, but also have a greater risk of loss. Investors can choose stocks based on a wide range of criteria and characteristics, including the type of company and industry, the size of company, location, and sensitivity to broad economic trends.