Stocks are divided into categories for specific reasons. Companies are divided by market capitalization (i.e. large-cap, mid-cap, small-cap). They may also be categorized as to whether they are domestic or international or whether they are focused on growth or value. But for many investors that just helps to identify an investor’s risk profile.
Within any market capitalization group, stocks can fall into different sectors. And stocks can perform differently depending on that sector. For example, a utility stock will perform very differently than a technology stock. But even within the technology sector, there are numerous distinctions in the way companies are classified.
The lucrative mutual fund and now exchange-traded fund (EFT) industries are based on the premise of safety in numbers. Rather than try to choose individual stocks, a mutual fund or ETF invests in a group (often referred to as a “basket”) of stocks. And since their earliest days, these funds branched out into distinct funds that targeted specific sectors. For example, you could own an ETF that focuses on the technology sector.
But increasingly, investors can get even more granular by drilling down to specific areas within the technology sector. For example, they can invest in semiconductor stocks or information technology stocks. And in 2020, there are categories such as marijuana stocks and coronavirus stocks that didn’t exist just a few years ago.
Investing in different stock categories is an important part of a balanced portfolio. What follows is a list of specific stock categories and why investors may want to consider them as part of a balanced portfolio.
Blue-chip stocks are named after the color of poker chips that traditionally represent the highest value. But blue-chip stocks are not based on the price of a stock. One of the primary characteristics of a blue-chip stock is that the company must have a market capitalization of over $5 billion dollars. These are large-cap stocks.
Aside from the market cap requirement, blue-chip companies are companies with solid balance sheets. Analysts count on these companies to deliver consistent, quarterly earnings growth that they return to their shareholders in the form of a dividend. Many, but not all, blue-chip companies are dividend aristocrats. This means the company has increased, and paid out, its dividend for at least 25 consecutive years.
Blue-chip stocks at times do produce capital growth. But that is not the primary objective for these stocks. Blue-chip stocks generally have a beta of around 1. Beta measures how correlated a stock is to the broader market. A beta of 1 suggests that the company moves fairly consistently with the market. This means that blue-chip stocks aren’t necessarily riskier than an index stock, but they are not less risky either.
There are many mutual funds and ETFs that specialize in blue-chip stocks. This is a good way for investors to benefit from rising dividends without having to pick individual stocks.
The novel coronavirus that has spawned the Covid-19 pandemic is creating its own category of coronavirus stocks. In the span of just a few weeks, the economic fallout from the Covid-19 pandemic is playing out in homes and businesses throughout the world. Entire industries and sectors have been effectively shut down.
While it’s somewhat predictable that certain market segments such as the oil and gas industry would struggle due to demand destruction, there are other segments that are outperforming the market. For example, as the economy seeks to reopen, there are several biotech stocks that are outperforming the broader stock market.
As millions of Americans are now working from home, it’s increased certain aspects of the technology sectors. For example, Zoom Communications (NASDAQ:ZM) is up over 100% in 2020. And another stock that is premised on a remote workforce, Docusign (NASDAQ:DOCU) is up nearly 50% for the year.
Having more Americans staying at home also means that restaurants and gyms are closed. This is increasing the stock price of companies like Blue Apron (NYSE:APRN) and Peloton (NASDAQ:PTON) that cater to a consumer that is at home.
Nobody knows what the ripple effects of the coronavirus will be in our economy. Many businesses that are closed may never reopen. Some trends, like working from home, may become a larger part of our society. Certainly, large gatherings will be placing a higher emphasis on the health of those entering facilities.
What will this ultimately mean is tough to say. And that’s why coronavirus stocks are an appealing investment. Even as the U.S. economy strives to achieve a new normal, there are some industries that will fundamentally change. Coronavirus stocks can be thought of as stocks that are positioned to thrive not only now but in the future.
This is one of the most well-known categories of stocks. Unlike other categories that can be somewhat arbitrary, the group of FAANG stocks is limited and specific. FAANG is an acronym that is comprised of the first initial of an elite group of technology stocks, namely Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Netflix (NASDAQ:NFLX), and Alphabet which is the parent company of Google (NASDAQ:GOOGL).
One common denominator of all FAANG stocks is that they trade on the NASDAQ stock exchange. In fact, the FAANG stocks make up approximately 1% of the S&P 500 Index, which is considered to closely approximate the broader stock market. In terms of weighting in the S&P 500 only Netflix is not in the top 10 (at the time of this writing, Netflix was ranked number 24).
In contrast to blue-chip stocks, FAANG stocks are growth stocks. This means that these companies choose to reward their shareholders by investing their profits into growing its business as opposed to returning it to shareholders in the form of dividends or share buybacks. To that end, only Apple offers a dividend.
The FAANG stocks are among the most expensive stocks to own in terms of share price. And while they may represent a good value, it may be hard for the average investor to buy individual shares. A good alternative for investors may be to purchase a mutual fund, index fund, or exchange-traded fund (ETF).
Marijuana stocks make up one of the most intriguing sectors in the entire stock market. Marijuana stocks became popular in 2018 based on the promise of incredible growth in the cannabis industry. As many countries continue to legalize marijuana for medicinal and/or recreational purposes.
If you go on the investing app Robinhood, marijuana stocks are among the most highly traded. One of the reasons for this is that a high percentage of Robinhood users are categorized as millennials. These investors are the true believers about the medicinal benefits of cannabis. And, in many cases, are simply betting on the opening up of the recreational market.
It also doesn’t hurt that many of the most commonly traded marijuana stocks also fall into the category of penny stocks. This further emphasizes the risk associated with this emerging market.
The cannabis industry is diverse. The most well-known names among marijuana stocks are the growers such as Canopy Growth (NYSE:CGC) and Aurora Cannabis (NYSE:ACB). But the industry is actually much more diverse than that. Some companies are not involved in the growing aspect at all. However, they may be involved in pharmaceuticals research, horticulture, or the development of derivative products such as edibles and vapes.
In some cases, a company may be involved in more than one aspect of the cannabis industry. Understanding a company’s business model is critical to understanding if its stock is a good investment.
Options trading is not a separate category of stocks. Rather, it’s a different way of trading securities. In the interest of readability, the rest of this section will focus on stocks, but investors can use options to trade many types of securities.
An options trade is a contract between a buyer and a seller. The buyer of the contract purchases the right (but not the obligation) to buy or sell a quantity of stock. When a buyer enters into an options contract with the intention of buying a stock, it is known as a call option. In this case, the buyer believes the stock price will rise before the option expires and the seller will have to sell him shares at a lower price.
When the options contract is written with the intention of selling a stock, it is known as a put option. In this case, the buyer believes the stock price will decline before the option expires and the seller will have to buy shares at a higher price.
The terms of the contract include both a specified price (the strike price) and a specified date (the expiration date). The time period of an options contract can be a month, a quarter, or longer. The only condition is that the option must be exercised in a “reasonable period of time.”
Because an investor does not have the obligation to purchase or sell the stock, the owner of the contract will receive a fee. In that way, if the contract expires the owner at least collects the fee (or premium) from the expiring contract.
Another difference between options trading as opposed to trading individual stocks is that option trades must be done through a broker. Since the dot-com boom, brokers have done a better job of providing investors with educational tools that help them understand the mechanics as well as the risks of options trading.
According to the Securities & Exchange Commission (SEC), penny stocks generally fit into the category of stocks that sell for less than $5 per share. Although there is no standard definition for what makes a stock a penny stock, the common trait is that these stocks sell for “pennies on the dollar.”
While it’s easy to see their low cost of entry as being a potential reward of a penny stock, it’s important to understand the risk that these stocks carry. Let the buyer beware is very applicable to these stocks. In some cases, a penny stock is a penny stock because it operates in a very specific niche and just doesn’t draw a lot of attention from investors. It may have few catalysts for long-term growth so there’s nothing creating demand for the company’s stock.
If a penny stock is listed on one of the major stock exchanges, they will have to meet SEC minimum filing requirements. This means investors will have access to at least the company’s basic financial information. There are many brokers that publish lists of viable penny stocks.
However, in many cases, a company’s stock is trading at low levels because it is in financial trouble. If a publicly traded stock on a major exchange falls below $1 for a length of time, it runs the risk of being delisted. Although many companies avoid that fate, it doesn’t always mean the company is healthy. A scenario that is even riskier is when a penny stock is listed on the Pink Sheets or the Over-the-Counter Bulletin Board (OTCBB).
In both cases, it means that the company does not have to file information with the SEC. And that means that it is impossible for investors to verify any claims that the company may make.
Preferred stocks are a separate class of stocks from common stocks. When a company offers preferred stock (and not all do), it is giving those shareholders priority over common stock shareholders in several key areas.
One such area is a dividend. In general, the preferred stock carries a higher dividend than common stock. And whereas, the dividend paid to common shareholders is variable, the dividend paid to preferred shareholders is fixed. The ability to collect this fixed dividend no matter the economic conditions is a key reason investors buy preferred stock.
Another area that preferred stock is different is the security of the shares if the company were to file for bankruptcy or other financial trouble. Where common stock shareholders are at the end of the line, preferred stockholders stand a better chance of at least receiving some return on their investment.
Preferred stock does not tend to provide a lot of capital growth. But that’s only because the price does not move based on supply and demand. Investors are buying the stock for the fixed dividend and therefore are not concerned about the long-term growth.
One “negative” is that preferred stock does not come with voting rights. I put negative in quotes because many preferred shareholders really are not interested in being involved in the company’s day-to-day operation. They simply want the dividend.
Real Estate Investment Trusts (REITs)
Investing in real estate is a tried-and-true investment strategy. But property management is not every investor’s strength. The intention of a Real Estate Investment Trust (REIT) is to allow investors the ability to invest in real estate without buying or financing (and managing) property. A REIT consists of numerous real estate companies that own a portfolio of income-producing real estate assets. When an investor invests in a REIT, they earn a portion of the income these assets produce.
The two categories of REITs are equity REITs and mortgage REITs. Equity REITs such as Avalon Bay Communities (NYSE:AVB) are generally for commercial properties that receive their primary income from rent payments. This is the most common form of REIT with over $2 trillion of assets under management.
A mortgage REIT is primarily composed of residential properties that are backed by mortgages or mortgage-backed securities. A mortgage REIT profits from the spread between the interest rates they earn from their mortgage loans and the short-term borrowing rates. New York Mortgage Trust (NASDAQ:NYMT) is an example of a mortgage REIT.
One of the most desirable features of REIT stocks is that they must payout at least 90% of their profits as dividends. REITs have no retained earnings.
Warren Buffett Stocks
As this category’s name states, stocks in this category are stocks owned by Warren Buffett’s hedge fund Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B). Buffett has been successful because he follows an investment strategy in which he takes large positions in stocks that he believes have a high probability to grow. In 2018, the top four positions in Berkshire Hathaway’s portfolio carried over 10 percent of its weight.
His buy-and-hold strategy may not be appealing to every investor. However, when Buffett takes a position in a new company or buys more shares of a stock he already owns, investors generally see that as a positive sign. In fact, Buffett is famously known for quipping for investors to be greedy when others are fearful (and vice versa). This frequently means that many Warren Buffett stocks perform well during periods of market volatility.
On the contrary, when Berkshire sells stocks it is generally seen as a vote of no confidence. One of Buffett’s core principles is that investors should invest in what you know. And that means that many Warren Buffett stocks are well-known names like Apple (NASDAQ:AAPL) and Coca-Cola (NASDAQ:COKE).