Investing 101

Buying stock in a company means buying part ownership in that business. As a shareholder, you receive capital appreciation (the difference between your purchase price and the current market value) and/or dividends (generally a quarterly payment that represents a percentage of the company's earnings). Of course, stock prices and dividends can fall if the company doesn't do well.

Stocks can be classified into several broad categories:

Blue chip stocks are the high-quality stocks of major companies; they generally have long and unbroken records of earnings and dividend payments.

Growth stock companies are those whose sales, earnings and market share are expanding faster than the industry average and the economy in general. These companies usually retain most of their earnings to finance expansion and pay little, if any, dividends to shareholders.

Defensive stocks are from companies that provide necessary services, such as electricity and gas; essential goods, such as pharmaceuticals; or staples, such as food or soft drinks. Due to the constant demand of these products, the stocks provide a degree of stability during periods when the economy is declining.

Income stocks are generally attractive to people seeking immediate income, particularly seniors and retirees. Income stocks, primarily public utilities, usually pay high dividends in relation to their market price, providing shareholders with greater quarterly income.

Cyclical stocks are those of companies whose earnings are tied to the business cycle. When business conditions are good, the company is profitable and the common stock price usually rises. When conditions decline, the company's earnings and stock prices generally fall. Steel, cement, machine tools and automobile companies are considered cyclical stocks.

Seasonal stocks' performance fluctuates with the seasons. For example, retail companies' sales and profits normally increase at Christmas and the beginning of the school year.

This article was originally published in the January 1996 print edition of Entrepreneur with the headline: Investing 101.