Stock classifications: From blue-chip to speculative

Some stocks come with high levels of risk but offer investors the opportunity to double or triple their return in a short time. Other stocks are expected to gradually rise in value while paying out a very stable dividend. And then there’s everything in between.

There is no one-size-fits-all formula to determine what stock types should be bought by investors. Younger people are more often able to absorb losses from higher-risk stocks because they are decades away from retirement. On the other hand, someone close to retirement age may want to protect their money at all costs and a large loss could be devastating to their retirement fund.  Conversely, a young investor may have limited financial resources as well as near-term financial objectives (e.g., down payment on a house) that would make risky investments untenable. Moreover, an older and more established investor may be in a better position to absorb investment losses.

Here is a summary of some different stock classifications.

Penny stocks can consist of companies of all shapes and sizes and across all industries. However, the term is mostly reserved for very small companies.

Savvy and skilled investors will comb through dozens of penny stocks at a time to find a company undervalued or overlooked by the majority of investors. Finding a winner can offer investors potential big returns over time as other investors begin to understand the stock’s true potential.

A blue-chip stock is the complete opposite of a penny stock since it refers to elite companies with valuations in the tens of billions of dollars. The term derives from the world of gambling: in a set of poker chips, the blue-coloured chip is worth the most.

Blue chip companies are often industry leaders. Younger investors often think of them as boring, but these stocks are popular among older investors because they typically offer more safety and a steady dividend payout.

As the name implies, an income stock refers to any stock that generates income for the investor, usually in the form of dividends. Income stocks pay investors a dividend yield that often ranges from as low as 2% of the stock's total value to as much as 15% a year. Income investors typically don’t expect to see much or any additional gains from the stock’s appreciation.

Many investors take advantage of income stocks since the Canadian tax code offers special treatment for dividends.

Growth stocks refer to companies that are expected to expand their business at a much faster rate compared to the average company. Established banks or telecom operators typically show minimal if any growth because of the very mature state of the market they operate in.

On the other hand, cloud computing companies or those working in artificial intelligence could show accelerated growth rate for years, since these types of markets are still in their infancy.

Penny stocks and growth stocks are regarded as speculative, along with any type of stock with generally uncertain prospects. A speculative stock is one that investors think may perform well, without much concrete evidence to support this conclusion. Investors with low tolerance for risk mostly stay away from speculative stocks because the downside potential could be significant if the investor turns out to be wrong.