Residual Claim to Assets
In the event of a company’s bankruptcy or liquidation, common stockholders have the right to receive their proportional interest in residual assets. After all the other security holders have been paid, along with all creditors of the corporation, common stockholders may claim the residual assets. For this reason common stock is the most junior security.
Common stock can be classified into a number of categories. Each category details the characteristics associated with the underlying company.
- Blue chip: strong, stable and mature, with a long history of consecutive quarterly dividends; may also be a suitable investment for an investor with an income objective.
- Growth: strong potential for improving profits. The company's earnings are growing faster than the overall economy, and thus the stock has a strong potential for outperforming the market.
- Emerging growth industry: young firm in new industry with good growth prospects, but also high-risk.
- Income: mature company with high dividend yield and few prospects for growth or diversification. These are typically utility companies; however, they may also be blue chip companies.
Another way to classify common stock is based on the characteristics of the industry
- Cyclical stocks move with the broader market - and often with greater volatility - so they outpace the market during an expansion but whipsaw back during a contraction. Automotive stocks are one example.
- Counter-cyclical or defensive stocks do better in bear markets, when investors are looking for safe places - that are not affected greatly by economic currents - to park their money. Companies in the food, health care and defense industries are all examples.
- Speculative or special situation stocks are those that, for whatever reason, an investor believes will rise quickly in market price. There can be an element of guesswork here, but other factors may be at play too. Often, these are companies emerging from reorganization or bankruptcy. Sometimes investors will be drawn by the fact that a company's incompetent or corrupt management is being replaced by turnaround specialists. Alternatively, it might be that a company is either fundamentally undervalued or selling at the low end of its historic trading range and is thus ripe for a sharp upward movement in stock price.
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