Welcome to Ameritrade Plus University |
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Lessons:
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Different kinds of stocks Not sure what a small-cap is? Or why you should care? Read on. There are more than 9,000 stocks to choose from, so investors usually like to put stocks into different categories. You can slice and dice the stock market into all sorts of different groups, but the most common ways are by size, style, and sector. By size When talking about a company's size, we're referring to its market capitalization, the current share price times the total number of shares outstanding. It's how much investors think the whole company is worth. Ford, for example, has 1.6 billion shares outstanding, and in February 2001, each share was trading for $28, for a total market capitalization of $45 billion. (Technically, if you had an extra $45 billion lying around, you could buy each share of stock, and buy the whole company.) Is $45 billion a lot or a little? No official rules govern these distinctions, but below are some useful guidelines for assessing size.
Large-cap companies tend to be established and stable, but because of their size, they have less growth potential than small caps. As a result, over the long run, small-cap stocks have tended to rise at a faster pace. Krispy Kreme Doughnuts, a relatively new chain with a market cap of under $1 billion is slated to increases earnings at a 25 percent clip over the next five years, and its stock more than doubled in 2000. General Electric, the most highly valued company in the world with a market cap of more than $450 billion, has posted steady long-term returns, but don't expect a double anytime soon. But there's a trade-off: With less developed management structures, small caps are more likely to run into troubles as they grow -- expanding into new areas and beefing up staff are examples of potential pitfalls. (Of course, even corporate titans get into trouble. Witness the stock-price collapse of AT&T in 2000 -- stockholders lost more than 60 percent of their money.) By style A "growth" company is one that is expanding at an above-average rate. Cisco, for instance, increased its earnings at a rate of nearly 40 percent a year in the late 1990s -- the average tends to run around 10 percent. Catch a successful growth stock early on, and the ride can be spectacular. If you'd picked up 100 shares of Cisco in 1995, your stake would have cost you a little more than $3,000. By early 2001, that investment grew to $68,400. But again, the greater the potential, the bigger the risk. Growth stocks race higher when times are good, but as soon as growth slows, those stocks tank. Cisco fell from grace in 2000, with a decline of more than 50 percent. The opposite of growth is "value." There is no one definition of a value stock, but in general, its share price is in the dumps. Maybe the company has messed up, causing the stock to plummet -- a value investor might think the underlying business is still sound and its true worth not reflected in the depressed stock price. A "cyclical" company makes something that isn't in constant demand throughout the business cycle. For example, steel makers see sales rise when the economy heats up, spurring builders to put up new skyscrapers and consumers to buy new cars. But when the economy slows, their sales lag too. Alcoa, the leading aluminum maker, grew its earnings by 16 percent -- well above-average -- a year in the late 1990s, but might actually lose money if aluminum prices fall in the next recession. Cyclical stocks bounce around a lot as investors try to guess when the next upturn and downturn will come -- by the time you read aluminum prices are at a high, Alcoa probably has already peaked. By sector Standard & Poor's breaks stocks into 11 sectors, and 59 industries. Generally speaking, different sectors are affected by different things. So at any given time, some are doing well while others are not. Generally speaking, finance, health care, and technology are the fastest growing sectors, while consumer staples and utilities offer stability with moderate growth. The other sectors tend to be cyclical, expanding quickly in good times and contracting during recessions.
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