What kinds of shares can I buy?
There are lots of different kinds of shares, below we outline some of the common share terminology for the various categories.
Large, Mid and Small Capital Stocks: You may have heard these terms before. Large, Mid and Small refers to the market value of the company (also known as share capital). In Australia:
Large Cap Stock: The top 50 largest companies in Australia
Mid Cap Stock: The 51st to 100th largest companies in Australia
Small Cap Stock: The 101st to 300th largest companies in Australia
The definitions above are based on the S&P/ASX indices series. Some fund managers may use a different definition based on a set market capital, rather than a simple ranking. If you are investing in a Small Cap fund it is best to check what definition is being used.
Generally large cap stocks are the most liquid (which means that are easy to sell and usually have a low differential between the buy and sell price). Small cap stocks can be less liquid and may be riskier, as they are usually less established companies, when compared to those in the Large Cap indices.
Due to the higher risk in small cap stocks, you should expect a higher return when investing in them.
Value Stocks: A value stock is one that appears to be undervalued based on the fundamentals of the company. Some stock analysts will look at the company fundamentals, determine the fair value, and then purchase a stock if it is below this fair value. This is value investing.
Growth Stocks: A growth stock is one whose earnings and revenue are expected to increase at an above market rate. Growth stocks tend to be newer companies who are in the early growth phase. Typically such stocks do not pay dividends, as they are reinvesting the money in further growth. You would invest in a growth stock if increasing the value of your investment is your key concern, rather than dividends or capital preservation.
Private Equity: So far, all the shares that we have been talking about are listed on the stock exchange, and are therefore available to the public. However it is also possible to buy shares in companies that are not listed on the stock exchange, these shares are called Private Equity as they are not available to the public. Purchasing private equity is a very specialised field, and it is very risky. In later weeks we are going to cover private equity in more detail.
What are some of the key risks of investing in shares?
There are two broad categories for risk for investing in shares:
Specific Risks: Specific risk is the risk that belongs to each stock. For example, if you have invested in Company A, a technology stock listed on the Australian stock market then you have:
* Company Specific Risk: This covers risks related specifically to Company A. For example a movement in their share price due to a recent release of their sales data.
* Sector Specific Risk: Company A is a technology company, if news is announced that negatively impacts the technology sector, as part of that sector, Company A’s stock price is likely to fall. This is sector specific risk.
* Geographic Specific Risk: Company A is an Australian company. If news is announced that negatively impacts Australian stocks (e.g. weak employment data), Company A’s stock price is likely to fall. This is geographic specific risk.
Market Risks: Market risk is the risk that comes with being part of the stock market. If there is negative news, then the whole market is likely to react negatively and stock prices will fall. It doesn’t matter if you are invested in Company A, or Company B, all stock prices are likely to move in the same direction.
The above highlights some of the risks of investing in stocks. It is important to remember that there is no bottom to where a stock can fall. If a company runs into financial trouble, debtors (including bond holders) get paid first, and shareholders get paid last. This means that in an extreme case, your shares could be worth $0. Prior to making an investment, it is important to consider all the risks of that particular stock, and to minimise the risks as much as possible through diversification.
Next week we are going to cover some of the benefits and risks of investing in international stocks.
The information in this blog is of a general nature only and may contain advice that is not based on your personal objectives, financial situation or needs. Accordingly you should consider how appropriate the advice (if any) is to those objectives, financial situation and needs and before acting on the advice.