If you need a ride to financial freedom then the stock market is the vehicle to get you there. A stock is an investment made into a public limited company in form of issued shares, these shares make the capital for the business. Investors are keen to own stocks as it represents their ownership in a company, in doing so they are in the wealth creation process. Stocks are traded through the stock markets such as the Zimbabwe Stock Exchange, Johannesburg stock exchange, and London stock exchange.
Stocks provide returns that are excellent at a cost which is a risk. Financial decisions need to be taken seriously because generally risk and reward are offsets. Stocks inherit some degree of risk but the risk can be minimized by having knowledge. It is necessary for the investor to familiarize themselves with the types of stock available in the stock market. That being said let’s dive into the types of stocks.
These are stocks whose price is affected by microeconomic or systematic changes in an economy. Cyclical stocks are known to follow the performance of an economy. These are usually companies that sell products with substitutes or luxury items. Customers buy more when the economy is on a boom and buy less when the economy is in recession. The returns on these stocks are dependent on economic performance. They are generally the opposite of defensive stocks. Cyclical stocks have higher volatility(fluctuation) therefore investors and portfolio managers should exercise caution when choosing the weight of cyclical stocks at any given time.
Cyclical stocks tend to outperform during periods of high economic growth. Here are some of the most prominent industries whose stock can be cyclical, airlines, hotels, retails, restaurants, automakers, financial institutions. Better performance of cyclical stocks is when the economy is on the peek, an investor who invests in these kinds of stock should realize high returns. Cyclical stocks are more suitable for active investors usually professionals, speculators entrepreneurs, and business owners. Generally, these investors in cyclical stocks are those with medium to high-risk tolerance.
Defensive stocks are stocks that are strong in any environment, they are consistent and generally stable regardless of the state of the economy or the stock market. These are the companies whose products are consistently demanded so the performance of the business does not follow economic cycles. Defensive stocks offer gains in the long term at a lower risk. These stocks are lower in volatility and often leads to lower gains in the bull market due to market mistiming. Investors and portfolio managers seeking to protect their portfolios during recession or periods of high volatility are the favorites of defensive stocks. Companies with defensive stocks are those with stable operations and strong cash flows. Examples of the defensive stocks are companies in real estate, staple food producers, manufacturers of cigarettes, and those into energy. Since volatility is very low, this means low risk and also low returns, but one sure thing is stability.
Defensive stocks are for those with lower risk appetite and passive investors. To be more specific, pensioners and those that are closer to retirement can invest their funds in defensive stocks because they are stable. Defensive stocks have the ability to protect and preserve the value of an investment due to low volatility. An investor of medium to low risk appetite can balance a portfolio with more defensive stocks.
Blue Chip Stocks
A blue-chip is a stock in a large well-established company with an impeccable reputation of operating well for a number of years. These companies are the market leaders, they have market caps running into billions and include some of the biggest household names. These companies have the ability to absorb economic shocks and operate well in both good and bad times, paying dividends to their investors quite often. Blue-chip stocks are quite popular among investors because of these qualities.
As much as blue chips are attractive, they should not make up an investors entire portfolio, a portfolio has to be diversified to include small and medium cap stocks as well. There is not much growth in blue-chip stocks, which means a younger investor with a higher risk tolerance should have a greater percentage of their portfolio in small and medium caps then add blue-chip stocks to balance out the portfolio. Much older investors would have a larger percentage in blue-chip stocks as their risk appetite has decreased. A portfolio always has to be balanced. Always remember too much of anything is never good for you.
Hopefully this article shed some light on the type of stocks available, however these are not all.Stay tuned as next week Ruramai and myself bring you the second part of know your stocks.
Thanks to Ruramai Mukara who wrote these articles with me.