Companies issue two basic kinds of stock, common and preferred, and each provides shareholders with different opportunities and rights:
- Common stock: Represents ownership in a company. Companies can pay what are called dividends to their shareholders. Dividends are paid out from a company’s earnings and can fluctuate with the company’s performance. Note: Not all companies pay dividends. Common stock offers no performance guarantees, and although this kind of stock has historically outperformed other types of investments, you can lose your entire investment if a company does poorly enough to wipe out its earnings and reputation into the foreseeable future. Common stock dividends are paid only after the preferred stock dividends are paid.
- Preferred stock: Constitutes ownership shares as well, but this stock differs from common stock in ways that reduce risk to investors, but also limit upside potential, or upward trends in stock pricing. Dividends on preferred stock are paid before common stock, so preferred stock may be a better bet for investors who rely on the income from these payments. But the dividend, which is set, is not increased when the company profits, and the price of preferred stock increases more slowly than that of common stock. Also, preferred stock investors stand a better chance of getting their money back if the company declares bankruptcy.
A company’s stock is also categorized depending on its perceived expected performance. Basically, a company’s stock falls into one of two categories: growth or value Over time, you’re likely to buy a mix of both types of stocks for your portfolio, so knowing the different characteristics of each is important. Understanding growth and value stocks can help you evaluate your options more carefully.
Growth companies are typically organizations with a positive outlook for expansion and, ultimately, stock prices that move upward. Investors looking for growth companies usually are willing to pay a higher price for stocks that have consistently produced higher profits because they’re betting the companies will continue to perform well in the future.
Because they use their money to invest in future growth, growth companies are less likely to pay dividends than other, more conservative companies; when they do pay dividends, the amounts tend to be lower. An investor who buys a growth stock believes that, according to analysis of the company’s history and statistics, the company is likely to continue to produce strong earnings and is therefore worth its higher price.
The stock of a growth company is, however, somewhat riskier because the price tends to react to negative company news and short-term changes in the market. Also, the company may not continue to produce earnings that are worth its higher price.
In contrast, value stocks are out of favor, left on the shelf by investors who are busy reaching for more expensive and trendier items. For that reason, you spend fewer dollars to buy a dollar of their profits than if you invest in a growth stock. When investors buy value stocks, they’re betting that they’re actually buying a turn-around-story — with a happy ending down the road.
Value companies carry risk, too, because they may never reach what investors believe is their true potential. Optimism doesn’t always pay off in profits.
Growth companies are typically organizations with a positive outlook for expansion and, ultimately, stock prices that move upward. Investors looking for growth companies usually are willing to pay a higher price for stocks that have consistently produced higher profits because they’re betting the companies will continue to perform well in the future.
Because they use their money to invest in future growth, growth companies are less likely to pay dividends than other, more conservative companies; when they do pay dividends, the amounts tend to be lower. An investor who buys a growth stock believes that, according to analysis of the company’s history and statistics, the company is likely to continue to produce strong earnings and is therefore worth its higher price.
The stock of a growth company is, however, somewhat riskier because the price tends to react to negative company news and short-term changes in the market. Also, the company may not continue to produce earnings that are worth its higher price.
In contrast, value stocks are out of favor, left on the shelf by investors who are busy reaching for more expensive and trendier items. For that reason, you spend fewer dollars to buy a dollar of their profits than if you invest in a growth stock. When investors buy value stocks, they’re betting that they’re actually buying a turn-around-story — with a happy ending down the road.
Value companies carry risk, too, because they may never reach what investors believe is their true potential. Optimism doesn’t always pay off in profits.
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