Types of Stocks: Importance, Benefits & Beginner’s Guide to Investing

0 min read

Stocks are essential components of the financial markets, representing ownership in a company. Investors buy stocks to gain financial returns through price appreciation and dividends.

What are Stocks?

Stocks are financial security that represents partial ownership in a company. When you purchase stocks, you become a shareholder, meaning you have a claim on the company’s assets and earnings.

Understanding Shares, Shareholders, Dividends & Equity

A share basically represents a unit of ownership in a company, which is issued by the latter to investors in exchange for money. Each share gives the owner a proportionate claim on the company’s profits (through dividends) and assets (if the company is liquidated).

Example of Shares

Let’s say a company issues a total of 1,000 shares, and you purchase 100 shares. Since you own 100 out of 1,000 shares, you effectively own 10% of the company. This means you have a 10% claim on the company’s profits and assets, and if dividends are distributed, you receive 10% of the total dividends issued.

Who is a Shareholder?

A shareholder is any individual or entity that owns one or more shares of a company. Shareholders are partial owners and may have certain rights, such as voting in company meetings, receiving dividends, and accessing financial reports. Their influence in decision-making depends on the number of shares they hold.

What is a Dividend?

A dividend is the profit generated by a company, distributed to its shareholders as a reward for their investment. It is paid in cash or additional shares at regular intervals, typically quarterly or annually.

However, it must be noted that not all companies offer dividends, as some prefer to reinvest profits for growth.

What is Equity?

Equity represents ownership in a company, usually in the form of stocks or shares. It gives shareholders a claim on the company’s assets and earnings after deducting liabilities.

Types of Stocks

Let us now study some of the most common types of stocks in detail: 

1. Based on Ownership Rights

Common Stocks: These provide ownership in a company and voting rights in shareholder meetings. Investors earn returns primarily through capital appreciation and dividends, though dividends are not guaranteed.

Preferred Stocks: These also represent ownership but typically do not grant voting rights. They offer fixed dividends and take priority over common stocks in case of liquidation.

2. Based on Growth Potential

Growth Stocks: Issued by companies with high revenue and profit growth rates. These stocks usually reinvest earnings rather than pay dividends and are known for their potential capital appreciation.

Value Stocks: Undervalued stocks compared to their intrinsic worth, as determined by fundamental analysis. Investors purchase them expecting a future price adjustment to reflect their true value.

3. Based on Dividend Payment

Dividend Stocks: These consistently distribute a portion of earnings to shareholders in the form of dividends.

High-Dividend Yield Stocks: Offer above-average dividend payouts, often preferred by income-focused investors.

Dividend Growth Stocks: Companies with a proven history of consistently increasing dividends, reflecting their financial stability and growth potential.

4. Based on Market Capitalization

Large-Cap Stocks: Issued by well-established companies with a large market capitalization. These are considered stable investments.

Mid-Cap Stocks: Represent companies that have moderate market capitalization and offer a balance of growth and stability.

Small-Cap Stocks: Stocks of relatively smaller companies with high growth potential but increased risk.

Micro-Cap & Nano-Cap Stocks: Represent the smallest publicly traded companies, often highly volatile and speculative.

5. Based on Trading & Listing Status

IPO (Initial Public Offering) Stocks: Shares of a company that has recently gone public, often volatile in the early trading phase.

Penny Stocks – Low-priced stocks that trade at very small market values. These are highly speculative and carry high risk.

6. Based on Industry & Economic Sensitivity

Defensive Stocks: Stocks that remain stable even during economic downturns. These belong to industries like healthcare, utilities, and essential consumer goods.

Cyclical Stocks: Stocks that perform well during economic growth but decline during downturns. These are linked to industries like automobiles, travel, and luxury goods.

7. Based on Risk & Speculation

Speculative Stocks: Stocks that carry high risk due to uncertain business fundamentals but have the potential for significant returns. These are often driven by market speculation.

Blue-Chip Stocks: Shares of well-established, financially stable companies with a history of steady performance, making them relatively low-risk investments.

8. Based on Ethical & Thematic Investing

ESG (Environmental, Social, and Governance) Stocks: Stocks of companies that prioritize sustainability, ethical business practices, and social responsibility.

Thematic Stocks: Stocks tailored to long-term investment themes, including renewable energy, artificial intelligence, and electric vehicles.

Examples of How Stocks Work

Here are a few examples to illustrate how stocks work:

Buying and Selling for Profit

• You buy 100 shares of Company A at ₹500 each (total ₹50,000).
• A year later, the stock price rises to ₹700.
• You sell your shares for ₹70,000, making a ₹20,000 profit.

Dividends as Passive Income

• You own 200 shares of Company B, which pays a ₹10 dividend per share annually.
• You receive ₹2,000 as passive income while still holding your shares.

Long-Term Growth (Wealth Creation)

• You invest ₹1,00,000 in a growth stock that appreciates 15% annually.
• In 10 years, your investment grows to ₹4,05,000 due to compounding returns.

Stock Split

• A company announces a 2-for-1 stock split.
• If you had 50 shares at ₹1,000 each, you now have 100 shares at ₹500 each.
• The total value remains the same, but more investors can afford the stock.

Risk of Stock Decline

• You buy shares of Company C at ₹800, expecting growth.
• Due to poor financial performance, the stock falls to ₹600.
• You either sell at a ₹200 per share loss or hold, hoping for a recovery.

Types of Stocks in India 

In India, stocks are categorized based on various factors like market capitalization, risk, and investor preference. Here are the popular types of stocks in India:

Based on Market Capitalization

Large-Cap Stocks: Companies with a market capitalization of ₹50,000 crore or more, known for their stability and strong market presence (e.g., Reliance Industries, TCS, HDFC Bank).

Mid-Cap Stocks: Companies with a market capitalization ranging between ₹10,000 crore and ₹50,000 crore, offering a balance of growth potential and stability (e.g., Tata Power, MRF, Voltas).

Small-Cap Stocks: Companies with a market cap of less than ₹10,000 crore (e.g., India Cements, Tanla Platforms).

Based on Growth Potential

Blue-Chip Stocks: Stable, well-established companies with consistent returns (e.g., Infosys, HUL, ITC).

Growth Stocks: Companies with potential for future growth, often in emerging sectors (e.g., Adani Green, Zomato).

Penny Stocks: Low-priced stocks of small companies, often risky (e.g., some micro-cap companies).

Based on Investment Strategy

Dividend Stocks: Stocks that regularly pay dividends (e.g., Coal India, ONGC).

Defensive Stocks: Less affected by economic downturns (e.g., FMCG, Pharma like Nestlé, Sun Pharma).

Cyclical Stocks: Perform well during economic booms but poorly in recessions (e.g., Auto, Real Estate like Maruti Suzuki, DLF).

Based on Sector

IT Stocks: TCS, Infosys, Wipro

Banking & Financial Stocks: HDFC Bank, SBI, ICICI Bank

Pharma Stocks: Sun Pharma, Cipla, Dr. Reddy’s

Auto Stocks: Tata Motors, Bajaj Auto, Hero MotoCorp

Energy Stocks: ONGC, NTPC, Reliance Industries

FMCG Stocks: Hindustan Unilever, Nestlé India

Importance of Stock Investment 

Stocks are the backbone of modern economies, impacting businesses, investors, and governments. Their significance goes beyond just trading; they drive economic expansion, wealth creation, and financial stability.

Encouraging Investment & Business Expansion

Companies raise funds by issuing stocks, enabling them to expand operations, launch new products, and invest in cutting-edge technologies. Strong stock markets attract foreign and institutional investments, helping businesses access global capital.

New and growing businesses benefit from equity financing rather than relying solely on debt, reducing financial strain.

Enhancing Liquidity, Allowing Quick Buying & Selling

Stock markets ensure that investors can easily buy and sell shares without major price fluctuations. High liquidity means investors don’t need to hold assets for long periods, offering flexibility in financial planning.

Liquidity also helps in market stabilization, as constant buying and selling prevent extreme price swings.

Helping in Wealth Creation Over Time

Stocks generate returns through capital appreciation (increase in share price) and dividends (company profits shared with shareholders). Equity investments generally outperform inflation, preserving and growing purchasing power over time.

Long-term stock market participation, through SIPs (Systematic Investment Plans) and diversified portfolios, helps investors achieve financial independence.

Providing Capital Allocation Efficiency for Economic Growth

The stock market helps in efficiently distributing resources to companies with robust financials and growth potential.

Businesses with solid fundamentals receive capital, leading to job creation, improved products, and higher productivity. Stock performance reflects a company’s true value, helping investors make informed decisions.

Supporting Government & Infrastructure Development

Governments benefit from strong stock markets as they increase corporate profitability, leading to higher tax revenues. Stock exchanges allow companies involved in infrastructure, technology, and manufacturing to secure funding, driving national development.

Public-private partnerships (PPPs) often use stock markets to raise funds for large-scale infrastructure projects.

Offering Diverse Investment Opportunities

Stocks cater to different risk appetites, from conservative investors (blue-chip stocks) to high-risk traders (penny stocks). Mutual funds, ETFs, and index funds allow indirect stock market participation for those who prefer professional management.

Global stock markets provide cross-border investment opportunities, enabling portfolio diversification.

Promoting Economic Stability & Confidence

A well-functioning stock market is a barometer of a nation’s economic health, influencing both domestic and foreign investor confidence. Rising stock indices indicate economic prosperity, attracting investments and boosting corporate activities.

Governments and central banks monitor stock markets to shape monetary policies and financial regulations that ensure stability.

Benefits of Investing in Stocks

Stock market investments offer numerous advantages that help investors build wealth and achieve financial stability. Beyond potential gains, stocks provide flexibility, liquidity, and long-term financial security. 

Here’s a detailed look at why stocks are a preferred investment option:

High Returns

Stocks have historically generated higher profits compared to traditional investments like fixed deposits, bonds, and savings accounts.

Over the long term, stock markets have consistently outperformed inflation, ensuring real wealth creation. Compounding returns from reinvested dividends and capital appreciation lead to exponential growth.

Dividend Income

Many well-known companies distribute a portion of their profits to shareholders as dividends. Dividends serve as passive income, which is particularly beneficial for retirees and long-term investors.

Reinvesting dividends through Dividend Reinvestment Plans (DRIPs) further enhances wealth accumulation.

Liquidity

Unlike real estate or fixed deposits, stocks can be quickly purchased and sold on stock exchanges. High liquidity ensures that investors can convert their investments into cash without long waiting periods.

Stock market trading offers multiple order types (e.g., limit orders, stop-loss orders) to ensure efficient transactions.

Inflation Protection

Inflation erodes the value of money, but stocks tend to rise over time, helping investors protect their purchasing power. Companies adjust product prices, wages, and earnings in response to inflation, leading to higher stock valuations.

Diversification

The stock market offers various sectors (IT, healthcare, finance, manufacturing, etc.) to invest in, reducing risk exposure. A diversified portfolio helps balance market fluctuations, ensuring stable returns.

Ownership & Voting Rights

Owning equity in a company gives shareholders voting rights, allowing them to participate in major business decisions. Investors with substantial shares can influence corporate policies, mergers, and board elections.

Tax Benefits

Long-term capital gains (LTCG) tax on equities is lower compared to interest earned on fixed deposits. Stocks offer tax-efficient investment options like Equity-Linked Savings Schemes (ELSS) under Section 80C in India.

Accessibility

As a beginner in stock investment, you can start with as little as ₹1,000 or ₹100, making it accessible for you to start at the initial stage.

Owning stock has become more accessible than ever, thanks to online trading platforms and brokerage firms. Whether you want to invest directly in individual stocks or opt for professionally managed funds, there are multiple ways to participate in the stock market.

Step-by-Step Explanation of How to Own Stock

1. Open a Demat & Trading Account

To buy and hold stocks electronically, you need to open a Demat Account in order to store your purchased stocks in a digital format. Additionally, you will also be required to open a Trading Account to assist you in buying and selling of stocks.

2. Link Your Bank Account

Your bank account must be linked to your trading account for fund transfers. This allows you to deposit money to buy stocks and receive earnings from selling stocks or dividends.

3. Choose Stocks to Invest In

Before investing, conduct market research on company performance, industry trends, financials, and future growth prospects. 

4. Place a Buy Order

Once you select a stock, place a buy order through your brokerage platform. You can choose different order types:

Market Order: Buy at the current market price.

Limit Order: Buy at a specific price or better.

5. Monitor Your Investments

Regularly check your stock performance through your trading app or brokerage portal, as well as company news, market trends, and economic conditions, and accordingly decide when to hold, sell, or buy more based on performance and market conditions.

Pros and Cons of Investing in Stocks

Pros of Investing in Stocks

High Return Potential: Higher returns compared to fixed-income assets.

Liquidity: Stocks can be quickly bought and sold at the investor's discretion, ensuring easy access to funds.

Diversification: Reduces investment risk by spreading across sectors.

Dividend Earnings: Some companies provide regular dividends.

Ownership & Voting Rights – Shareholders have a say in corporate decisions.

Cons of Investing in Stocks

Market Volatility: Stock prices fluctuate, causing potential losses.

Risk of Loss: Unlike fixed deposits, stocks do not guarantee returns.

Time-Consuming: Requires research, analysis, and monitoring.

Emotional Decision-Making: Investors may react impulsively to market movements.

Company-Specific Risks: Poor management or business failures can impact stock value.

Conclusion 

In conclusion, the stock market offers vast opportunities for investors to grow their wealth. Whether you're a beginner or an experienced investor, understanding the different types of stocks and their benefits and risks is crucial for making informed investment decisions.

Therefore, it is highly recommended that you conduct thorough research, seek financial advice, and consider diversifying your portfolio to minimize risks before investing. With the right approach, stocks can be a powerful tool for wealth creation and long-term financial security.

Frequently Asked Questions (FAQs)

1. What is a stock?

A stock represents ownership in a company. When you buy a stock, you own a small part of that company and may benefit from its growth and profits.

2. What are the main types of stocks?

The main types of stocks include common, preferred, growth, value, and dividend stocks.

3. How do stocks work?

Companies issue stocks to raise capital for growth and expansion. Investors purchase these stocks with the expectation of earning returns.

4. How can I make money from stocks?

Investors earn money through capital appreciation (when stock prices increase) and dividends (a portion of company profits shared with shareholders).

5. Is investing in stocks risky?

Yes, stock prices can fluctuate due to market conditions, company performance, and economic factors. However, research, diversification, and long-term investing can help manage risks.

Suggested Reads:

• Marketing Analytics: Must-Know Metrics & How to Use Them
• Market Trends & Economic Indicators: What MBAs Should Know For Interviews
• What Is Demand In Economics? Definition, Types, Law & Determinants
• What Is Monopoly? Definition, Features, Types, Impact & Antitrust Laws
• What Is Elastic Demand?: Understanding Its Factors & Types With Examples