How Common and Preferred Stock Behaves
Preferred stock appeals much more to investors who are looking to use the stock to earn income over time, and especially are looking for a stable rate of return in perpetuity. This can be an attractive type of investment indeed to investors who are looking for stability and the ability to earn a decent return from dividends.
Dividends with preferred stock are either guaranteed at a certain rate or are adjustable, for instance being set in reference to an interest rate indexes like the LIBOR. Adjustable rate shares may also have other stipulations based upon things like business performance that may affect their yields, but in all cases the dividends they pay are much more stable and reliable than common shares.
Common shares, on the other hand, have much greater liquidity as the number of shares issued is a lot larger, and these are the shares that people usually trade as well. So with more buying and selling going on, common shares are going to be a lot easier to trade and also have tighter spreads due to their greater supply and demand.
Common shares offer both the benefits of dividends and capital appreciation. Preferred shares do not change much in price, and usually trade close to their issue price. People usually buy stock as opposed to something else in order to see them increase in value over time, so if that’s your goal, it’s common shares that you want to be buying and holding.
Some preferred shares are callable, which means that the issuing company has a right to buy them back at the issue price if desired, according to their business needs. Sometimes a company may do this in order to close out these shares and issue a new series with a lower yield.
Companies can buy back common stock, but they must do so on the open market. Sometimes it makes sense for them to do this though, and depending on how much is purchased, this will drive up the demand for them as well as the price, in the short term anyway. With less of a company’s stock in the market, this also adds theoretical value to the outstanding shares left.
Preferred shares are more a reflection of a company’s credit worthiness, like bonds are, where common shares reflect a business’ current business conditions as well as future business prospects.
Other Distinctions Between Stocks
Sometimes companies will issue separate series of common stock to be able to provide different classes. When this is the case, you will see a dot and a letter after a stock’s symbol to designate which class the shares represent.
Stocks are also classified by market capitalization. This is what is meant by large cap stocks, medium cap stocks, and small cap stocks. This is all common stock that is being referred to, and larger companies are seen generally as being both more stable and being more liquid than medium cap stocks, which are seen as having these advantages over small cap stocks.
Many, but not all stocks are traded on stock exchanges, and among those, some are traded on traditional exchanges such as the NYSE, and some may be traded on electronic exchanges such as the NASDAQ. Some stocks aren’t traded on exchanges at all and are bought and sold directly from dealers, who maintain an inventory. These stocks tend to be very low cap and volume.
Some stocks are components of stock indexes, such as the Dow Jones 30, the S&P 500, or the NASDAQ 100. Stocks on major indexes tend to trade at higher volumes than they would otherwise due to all the portfolios, funds, ETFs, and derivatives that track indexes by trading in representative samples.
Some stocks are considered to be blue chip due to the size of a company and its history of success. Blue chip stocks tend to be preferred generally by a lot of investors, especially those who are looking to hold them long term, due to their perceived greater stability.
Stocks are also organized by sector, depending on the type of business the underlying company is in. Certain sectors are known for their various characteristics due both to investor behavior toward them and the risk involved in them. For instance, people might want to focus on a hot sector, and this can drive demand, like it did with tech stocks at various times in recent history.
Stocks are further segregated by income and growth potential. Stocks that tend to pay out regular and fairly reliable dividends are seen as income stocks, where stocks that have most of their potential vested in capital accumulation are seen more as growth stocks. Depending on one’s investment strategy, one may want to focus more on one or the other.
Classifying Stocks According to Price, Volume, Value, and Volatility
A stock’s price may influence its behavior, with lower priced stocks generally being more accessible to smaller investors than higher priced ones. Stocks are generally sold in lots of 100, so one needs to have enough capital to purchase at least that many, and the higher the price, the more investors will be able to afford a lot while keeping with their overall investment objectives.
This is the main reason stocks split, to bring the price down to increase their accessibility to the market. If not for splits, some stocks would be trading at very high prices, like Berkshire Hathaway Class A stock does, although in this case the decision to let the stock just run up was intentional. At over a quarter of a million dollars per share, the goal of keeping this stock exclusive certainly has been achieved.
Stocks generally trade at under $100 a share for this reason, although the companies don’t want to split it too much and have the price appear to be too low either.
Stocks also differ quite a bit by trading volume, with more volume being preferable, all other things being equal. Higher volume means more liquidity, or you at least need enough volume to make trading the stocks easy and with minimal spreads.
Stocks are also heavily judged by their perceived value, as a measure of things like their price to earnings ratio. This pertains more to long term rather than short term trends, as these business fundamentals are well correlated with long term stock performance, due to the expectation that this will continue.
Value investing also plays a role in deciding not only future capital accumulation but especially future dividends, and in essence you are deciding now reliable a company’s revenue stream will be in reference to the amount you invest in the stock.
Therefore, some stocks are considered to be value stocks, higher value stocks that is, where others which are trading at higher prices relative to their earnings for instance may be seen as having less value, although value here must be kept in perspective.
What value doesn’t always account for is the growth potential of a stock, where a company’s earnings are expected to increase significantly over time, where value calculations are done only in the present, the recent past actually.
Value investing has still proven to be a sound strategy overall though, although that should not be the only consideration. Warren Buffet for instance has done very well with this but that’s certainly not all he looks at, the company’s prospects matter as well for instance.
Some stocks are more volatile than others, and this can be seen as either a good or bad thing, depending on your strategy and your risk tolerance. Long term investors generally look for more stable stocks, less volatile, but a lot of their concern here is misplaced, as volatility is mostly a measure in the shorter term, where their time horizon is longer term so this shouldn’t matter much.
In the shorter term though, volatility increases both risk and reward, and those who are seeking the potential for higher rewards and higher returns generally will prefer more volatile stocks. You can make money both ways from stock movement, up or down, and the only time you can’t make much is when a stock’s price is too stable.
There are a lot of different categories of stocks, and it’s not only the individual company’s stock that matters, the kind of stock that it is often matters as well.