Here are the generally recognized categories that corporations fall into. There is no official organization that divines which type each corporation is. In fact, there is often spirited debate about what each corporation represents. It is in this exchange of views that investors on both sides of a disagreement become better educated.
As the economy evolves, certain areas, such as technology, expand faster than average while others dwindle. Corporations that operate in fast-growing sectors must emerge as one of the leaders because there is only room for a few companies solidly establish themselves and survive long term. For example, can you name the #3 Internet search engine? The #3 cell phone operating system? If not, then we’ve just illustrated that in these two areas, there is only room for two market leaders.
So, how do corporations give themselves the best chance to emerge as leaders in expanding markets? They “plow back” profits into the business to grow it as fast as possible. As a result, growth companies pay little or no dividends. How can we tell if a company is growing rapidly? It would be helpful to know that the average revenue growth rate of an S&P 500 company is around 3% to 4%. Any rate appreciably higher than this would qualify a corporation as a growth stock.
|Suitable for||Younger investors (who have the luxury of time to make up for losses) who want to take greater risks to build their wealth at a fast pace, or just ordinary investors who want to take a small portion of their wealth and aggressively invest it.|
|Examples||Workday (WDAY), Tesla (TSLA), Netflix (NFLX).|
|In the news||Cloud Software Is Booming — Just Ask Workday and Salesforce – September 1, 2017
Netflix Jump in New Users Fuels After-Hours Stock Surge – October 17, 2016
Why Wal-Mart Can’t Grow Anymore – February 28, 2016
|Connections||Growth corporations are the opposite of income corporations. They are less risky than emerging growth corporations whose markets are less assured.|
|A final word
|The problem with growth is that corporations become victims of their own success. They get so big that to add a significant percentage to their sales and profits becomes more difficult with each passing year. For example, for a corporation with $10 million in annual sales to grow 20%, it has to find customers to purchase another $2 million worth of products. For a corporation with $100 billion in sales to achieve the same growth rate, it has to find customers to purchase another $20 billion in products!
Even the most successful corporations eventually hit the wall, no longer able to find large market opportunities to pursue. When this happens, they start piling up profits. Eventually, their cash pile gets embarrassingly large and they are pressured by their shareholders to begin paying a steady dividend.
This decision represents the end of an era because it is an admission that the corporation is no longer the growth star it may have been for decades. A classic case is Microsoft, which began paying a quarterly dividend in 2003. A more recent example is Apple, which in 2012 began paying a regular dividend.
Let’s say that a corporation provides natural gas for heating and cooking to homes on a populated island through a network of pipes laid under the island’s streets. The company is in an interesting situation. On the down side, it doesn’t have opportunities to grow. On the upside, it doesn’t have much competition. For a would-be competitor to tear up all the streets on the island to lay gas pipes next to the company’s existing ones would be too costly.
So, what’s the company to do with the profits it consistently earns? The decision most of these companies make is to pay out a significant percentage of it to their shareholders who are, after all, the owners of the corporation. These payouts to shareholders are known as dividends. Holders of these corporations’ stocks go to their mailboxes four times each year (the number of times dividends are normally paid) and retrieve checks that represent significant income!
To determine whether a corporation is paying a substantial dividend, just divide the annual dividend the corporation pays by the price of a share of its stock. For example, if XYZ Corporation is paying $2 in dividends per year and its share price is $50, 2/50 * 100 (to make it into a percentage) equals 4%. This is called the corporation’s dividend yield.
|Suitable for||Retirees, those who need their invested money to earn (and pay them in cash) as much as possible. Because income corporations are well-established in their industries, they have a low chance of suffering major drops in their share prices because of a threat to the business, something retirees can ill afford.|
|Examples||Utility corporations National Grid (NGG) and Duke Energy (DUK).|
|In the news||Why Mattel is the ‘Top Dividend Stock of the Nasdaq 100’ With 4.9% Yield (MAT) – November 20, 2014
How to Pick Dividend-Paying Stocks – October 18, 2012
|Connections||An income corporation is the opposite of a growth corporation.|
|Explorations||1. Is a really high dividend too good to be true?
While doing research you may come across a corporation whose dividend yield is very high, perhaps 15%, 20% or more. It seems like you’ve discovered an amazing investment. However, you may be about to step into a trap. Informed investors may be selling their shares, driving the price down. The share price is the denominator of the dividend yield equation, so when it goes down, the yield goes up. Why would anyone sell the shares of a corporation that is paying such a relatively high dividend? They may know that because the corporation is doing poorly, perhaps even losing money, it will have to cut the amount of the dividend, perhaps dramatically. That incredible dividend yield you’ve discovered can disappear over night. A great exercise is to find corporations whose dividend yields are very high (15% or more). Read news about them, and try to figure out why their yields are so darn high! Following are examples of what can happen with a corporation whose dividend yield appears to be too good to be true:
Seadrill Plunges on Dividend Suspension as Rig Market Sours – November 26, 2014
Ferrellgas (FGP) Cuts Distribution, Strengthens Balance Sheet – November 24, 2016
2. What do the Canadians offer that’s so special?
3. Doubling down with dividends
|A final word
|A corporation doesn’t have to fit the classic definition of an income stock (ie, be well protected in a steady industry with few growth prospects) to have a high dividend yield. For example, from 2009 through the present, both AT&T (T) and Verizon (VZ), corporations who are in intensely competitive businesses, have dividend yields in the 4% to 5% per year range for a decade!
Finally, some financial advisors and investing newsletters focus exclusively on income investing, finding corporations whose shares not only have a high yield, but which also have a history of raising the dividend every year. They’ve been called by the financial press Dividend All-Stars and Dividend Aristocrats. An example of a corporation determined to reward its shareholders with increasing dividends:
Darden Restaurants raises dividend by 12.5% – June 27, 2017
Imagine if you were made an offer you couldn’t refuse. The offer is as follows:
You will be given $250,000 to invest. You must invest it in a single corporation and leave it invested in that corporation for 30 years. At that point, if the value of the investment has risen to $1 million or more, you can keep it!
If you do a little math, you will find that the investment only has to increase 5% per year to reach that target. You don’t have to pick the highest-flying stock you know to have a chance to keep the money. You would be better served selecting a corporation with proven staying power. This serves as our introduction to “blue chip” corporations.
Back in the day, blue was the color of the most valuable poker chip. The name gradually came to signify our strongest corporations. Blue chip corporations may not stand out in any one regard. They may not be growing as fast as growth companies or paying dividends as high as income companies. Their share prices may not be rising as fast as the latest darling of investors. All they do is use their market share, financial strength, brand recognition and solid management to grow steadily and continue dominating their markets.
|Suitable for||Investors who are conservative, but want to retain the opportunity to achieve income (through dividends) and growth in the value of their investments (through the share price increasing).|
|Examples||Visa (V), Home Depot (HD), Boeing (BA) plus many of the 30 members of the Dow Jones Industrial Average (DJIA).|
|In the news||GE slides to loss in 4Q, faces SEC probe over $15B charge – January 24, 2018
3 Blue-Chip Stocks at 52-Week Lows: Bargains or Busts? – August 25, 2017
Dow Set To Hit 22,000 At The Open, Charged By Apple Stock Rally – August 2, 2017
Clouds Darken for America’s Blue-Chip Stocks – November 13, 2014
Alcoa, H-P and Bank of America to Be Dropped from the Dow Jones – September 11, 2013
Blue Chip America Mints Money to Spend on Growth, Dividends – July 30, 2010
Dow kicks out GM and Citigroup – June 1, 2009
|Connections||Blue chip corporations are similar to defensive corporations in that they are among the least risky stocks to invest in. In fact, leading defensive corporations can also be considered blue chips.|
|Explorations||The scrap heap of history is littered with blue chips that have fallen from grace. They include: General Motors (GM – bankrupt and reformed using the same stock symbol), American International Group (AIG), Citibank (C), Kodak (KODK), and Xerox (XRX). Do historical research on several of these corporations and determine why each has fallen from grace.|
|A final word
|After reading our opening offer, you may have been tempted to identify Google or Apple as obvious choices. Keep in mind that Google was formed in 1998. It soon overtook Yahoo in search. Can we say with any confidence another corporation or technology won’t come along to take Google’s place?
Finally, some investors argue that there is no such thing as a blue-chip corporation. The two main reasons are:
Agree or disagree, and why?
These corporations sell things we need. Food comes to mind, of course, but also fuel, prescription drugs, and “consumer staples” like toothpaste, soap and laundry detergent. We even need the services of funeral homes to bury our dead!
The name “defensive” comes from the fact that if the economy is showing signs of faltering, you can defend your wealth by selling the stock in the corporations you are currently holding and buying the shares of these companies. While corporations that sell luxuries will likely see declines in sales and profits that will lead to falling stock prices, defensive companies will continue to chug along. We’ll keep eating, showering and brushing our teeth.
|Suitable for||Investors concerned about the state of the economy. Also, investors who are simply conservative.|
|Examples||Proctor & Gamble (PG), General Mills (GIS), Kimberly-Clark (KMB), Clorox (CLX), PepsiCo (PEP), and Nestle (NSRGY.PK)|
|In the news||The cereal that got General Mills out of the slump – December 20, 2017
Americans can’t afford U.S. medication, need a safe alternative – November 12, 2014
Campbell closing plants as soup consumption falls – September 27, 2012
Campbell Looks Way Beyond Tomato Soup – August 9, 2012
Frustration With P&G Grows – June 20, 2012
In Sour Economy, Some Scale Back on Medications – October 21, 2008
|Connections||The best defensive corporations, those that have been successful for several decades, can also be considered blue chip corporations.|
|Explorations||Using a financial site like Yahoo! Finance, chart the stock performance of one of the example corporations discussed above. Then, compare it to the performance of the Dow 30 or the S&P 500 (which represent the overall market) by overlaying one of these onto the same chart. See if the defensive companies sink less during times of recession than the overall market.|
|A final word
|Recessions can be deep and take their toll on the values of the shares of all types of corporations, even defensive ones. However, it is likely that the values of defensive stocks will fall much less than the average stock. This begs the question: “If, from reading the financial news it appears the economy is going into recession, why don’t I just sell all my stocks and wait until the recession passes?” There are two answers:
Finally, the solution to this problem could be your deciding to go on offense! See Counter-Cyclical on the left for ideas on how you can continue to build your wealth right through a recession!
Dexter and his friends are walking down the street. A group ahead sees something lying in the street. It’s a genuine Frisbee brand flying disc. Dexter watches as they take a quick look and walk past. When Dexter comes to it, he sees it’s dirty but otherwise in good shape. Yet, he walks past as well. Why did Dexter walk by the Frisbee?
This is the story of value stocks, companies that are being ignored by the vast majority of investors. Dexter probably walked by the Frisbee because he saw his buddies walk by it as well. No one wanted to be the person to pick it up. Corporations sometimes wind up being thrown in the gutter.
How, exactly does a corporation chase investors away? One way is to be associated with a stagnating or declining market. Even if the corporation is doing good things, if the market the corporation is operating in is not growing, over time investors may give up on it. This is the way many people feel about companies that make personal computers. Less of them are selling each year as consumers migrate to tablets and phones.
Another way to turn off investors is to have earnings “misses” quarter after quarter. The drop in the share price that can occur after an earnings miss can be demoralizing. Doing it again and again can cause investors to simply lose faith in the management of the corporation and give up by selling their shares. Below we see a great example in the huge networking equipment supplier Cisco Systems back in 2010:
Quarter after quarter investors bought Cisco’s stock, bidding it up before earnings (green arrows) in anticipation that it would get on track. Yet, time and again, Cisco disappointed investors (black arrows) and provided little indication it was getting a handle on its problems. The stock then plunged. Yet, being such as legendary corporation, Cisco enjoyed interest from new investors who figured they’d take their shot. Eventually, they gave up, too. The stock plummeted all the way down to about $16 and stayed there for four months (red oval). It was arguably a great value at that price.
|Suitable for||Investors who are extremely patient and insightful and who believe by purchasing the shares of good companies at low prices, they can take the downside risk out of their investments. Patience is required because it could take months to a year or more after an investor purchases a stock for the larger investment community to notice it is underpriced and begin sending it higher by purchasing it.|
|Examples||The Mosaic Company (MOS), Natuzzi (NTZ), Microsoft (from 2003 to 2013)|
|In the news||Value Managers Go on A Buyer’s Strike – November 07, 2013.
Jim Chanos On Hewlett-Packard: ‘The Ultimate Value Trap’ – July 18, 2012.
With Earnings on the Way, Is Cisco Still a “Value” Stock? – August 14, 2012.
2 Value Stock Treats Amid Tricky Market – October 31, 2011.
Microsoft Looks Cheap—as Usual – April 28, 2011.
|Connections||If a corporation’s share price has dropped significantly but it has not cut its dividend, this can increase its dividend yield as high as those of income corporations.|
|Explorations||Not every beaten-down stock is a great value. The term “value trap” has been coined for this reason. The share prices of many corporations which ultimately went bankrupt paused on the way down. The price would level off for weeks or months as investors began to believe that it had hit bottom and that it was a great value at its current price. Sometimes it turns out that this price level is simply a trap that draws many investors in. Sometime later, it resumes its slide to worthlessness.
Research stocks that have fallen significantly. What caused them to fall so much? In your estimation, can the corporation fix the problem and recover, making its current price a great value? Or, no matter how cheap the share price appears, is it simply a trap?
|A final word
|The father of value investing is Benjamin Graham. In 1949 he wrote the book The Intelligent Investor, which defined value investing principles. The most famous value investor is Warren Buffett, who over 50 years built Berkshire Hathaway (BRKA) into a massive holding corporation which owns dozens of other corporations. Among the corporations Berkshire Hathaway owns entirely are GEICO, Dairy Queen, and Benjamin Moore paints.|
The economy alternates between periods or cycles of growth and contraction (aka recession). When the economy moves from contraction to expansion, businesses and governments that had been holding off on construction projects and other investments give the go-ahead and buildings, bridges and roads are built.
Companies that provide basic materials such as cement and steel will do well when economies expand. Homebuilders are another example of corporations that will see greater demand for new homes when the economy is expanding and less demand if the economy is entering or in recession. As a result, these are known as cyclical corporations.
Cyclical corporations shouldn’t be associated only with construction. Can you name something that you would purchase if you were feeling flush financially, but definitely avoid if money was tight? You’d be identifying a consumer discretionary, a type of product or service that is a luxury you can do without.
|Suitable for||Investors who watch economic cycles and want to benefit more than usual as a country or region’s economy comes out of a recession.|
|Examples||Lennar Corporation (LEN), Alcoa (AA), BASF (BASFY), (CX), PPG Industries (PPG), United States Steel (X), USG Corporation (USG), Caterpillar (CAT).|
|In the news||U.S. Housing Market Has Gained Back All $9 Trillion in Value Lost During Recession, but Uneven Recovery Means Some Markets Still Lag – January 25, 2018
U.S. New Home Sales Hit Seven-Month Low as Prices Soar – August 23, 2017
Housing Recovery Checked by Cost Increases, Labor Shortages – May 02, 2013
Builders ready for home construction rebound – March 12, 2012
Births at 11-Year Low May Prolong U.S. Housing Market’s Five-Year Downturn – November 21, 2011.
Caterpillar Earnings Top Estimates as Economy Recovers – October 24, 2011.
Steelmakers Struggle – October 19, 2011.
|Connections||These corporations are the opposite of counter-cyclicals.|
|A final word
|The Caterpillar corporation (symbol CAT) holds a very special place among cyclical stocks. It makes earth moving bulldozers, dumptrucks and the like. If earth is being moved, something is about to be built (or mined) and Caterpillar equipment is going to be in the mix. This makes it a bellwether, a one-corporation indicator of the health of the global economy.
The economy alternates between periods or cycles of growth and contraction (aka recession). When the economy enters a recession. economic activity slows. Most corporations experience a drop in sales and profits, and consequently stock prices. However, certain types of corporations actually do better when an economy does poorly. These include dollar stores, pawn shops, payday lenders and collection agencies.
|Suitable for||Investors who monitor economic cycles and want to not just withstand an upcoming recession, but actually benefit from it.|
|Examples||FirstCash (FCFS), Dollar Tree (DLTR), PRA Group, Inc. (PRAA), Public Storage (PSA).|
|In the news||CFPB’s new federal rule on payday lending expected soon – August 17, 2017
First Cash to buy Cash America for $994 million in pawn deal – April 28, 2016
Dollar store fight gets nastier – September 11, 2014
Startup offers payday advances without the pesky loan-sharking – August 11, 2014
Ill. AG fighting debt-collection warrants – November 22, 2011
High Bank Fees Give Wal-Mart a Money Aisle – November 7, 2011
Not Unbanked: Untapped. Underserved Spend $45B On Financial Services – November 2, 2011
Weak Economy Is A Boon For This Pawn Services Company – November 1, 2011
Short-Term Lenders Seize The Day – October 19, 2011
|Connections||These corporations are the opposite of cyclical corporations.|
|A final word
|Just because an economy recovers doesn’t mean counter-cyclical corporations have to do poorly. For example, it’s possible that there may be a long-term trend from house to apartment downsizing that continues to benefit corporations like Public Storage.|
Is there anything more exciting than getting in on the ground floor of an amazing opportunity? Imagine you’re Eduardo Saverin meeting up with and partnering with another Harvard student named… Mark Zuckerberg.
As times change and technology advances, new industries and opportunities regularly arise. Can you name a few enormous new markets that were opened up over the last several decades? You may have come up with the Internet, wireless communications, smart phones, GPS mapping and clean energy.
When a new market is just starting to open, some corporations, often small, young, and able to act quickly, dive head first into the void in the hopes of emerging as the leader. Any profits it may achieve must be reinvested to grow the business as fast as possible. We call these businesses emerging growth corporations.
These corporations, often because they’re very small, may be able to ride the new market’s growth and double, triple or quadruple their revenues in a short period of time. The value of your stock may do the same! That’s the best scenario.
The negative scenario is either of the following:
- the new market never really materializes. For example, the conventional wisdom about 3D printers was that as soon as the price was brought down to the magic $1,000 (or lower) threshold, consumers would rush to get their own. The prices eventually came down, but the consumers stayed home. Critics would say “there’s no there, there.”
- the new market does take off with demand growing nicely, but many competitors, including larger ones with greater resources, barge in and ensure that the emerging growth corporation doesn’t, well, emerge.
|Suitable for||Young, aggressive investors who want to take a small portion of their investable assets and try to hit a home run.|
|Examples||GoPro (GPRO), Fitbit (FBIT), and 3D Systems (DDD).|
|In the news||GoPro shares fell 30% after it announced the end of its drone business, and it could be seeking a buyer – January 8, 2018
Garmin, Samsung Join Fitbit in Season of Wearables, Says Raymond James – September 1, 2017
|Connections||An emerging growth corporation, if it can manage to be one of the top few in a market that continues to expand, can become a growth corporation that may be able to reel off a decade or two of above average growth.|
|Explorations||Research the following markets and identify why they didn’t grow into something huge: consumer 3D printers, fitness wearables and consumer drones.
Biomedical corporations, ones on the leading edge of new approaches to treating illness, would be best categorized as emerging growth stocks. Many of these corporations, however, are working on a single drug for a single illness. If the company or the Federal Drug Administration (FDA) announces that trials have shown it to be ineffective, that can lead to epic losses for the shareholders. Imagine losing up to 80% of the value of that investment on the day the bad news is announced, and you get the idea.
If there’s a Wild West in the investing world, it would have to be “penny stocks”. These corporations get their name because their share prices are usually in the pennies (ie, less than a dollar) and are often less than one cent! For example, a penny stock may have a price of $.0033, representing a third of a cent.
What often makes a corporation a penny stock is the founders’ decision to “go public” (ie, sell shares to the broad investment community) before the company has a proven product or service. Investors who buy its shares at this point are taking a big chance because they’re buying into ideas (some would say dreams) that may or may not pan out.
For example, a company may claim that it is developing a part that, when installed in a car, doubles its gas mileage. The corporation says that it needs $1 million to finish the product, so it sells 10 million shares at $.10 each. If the company can actually complete this product, you may achieve gains. But it’s more likely that after a series of delays, the product is never actually released and your entire investment will be lost. There are other concerns with penny stocks, including:
- The stock price can swing wildly, doubling or losing half its value in a single day.
- It is often difficult to research them. If you bring up the symbol of a penny stock on a popular financial web site, many of the usual links will be dim because they are not available.
- Shares of these tiny corporations do not change hands between buyers and sellers all day long as with larger corporations. If you want to buy shares, you may have to pay a stubborn seller a high price to get his or her shares. If you want to sell, you may find little interest among buyers and have to drop the price you are willing to accept to motivate a buyer to step up and take them. The ability to sell quickly without having to drop the price significantly is called liquidity, and penny stocks lack it!
Finally, these companies don’t pay dividends. In fact, they may never have made a profit.
|Suitable for||People who prefer gambling over investing.|
|Examples||Here Media, Inc. (HRDI), HW Holdings (HHWW), Cardinal Resources Limited (CRDNF).|
|In the news||FINRA Fines Aegis Capital Corp. $950,000 for Sales of Unregistered Penny Stocks and AML Violations – August 3, 2015
SEC suspends trading in 255 dormant shell companies – February 2, 2014
The latest guilty pleas in Spongetech case – October 24, 2011
|Connections||Penny corporations are the opposite of blue chip corporations.|
|Explorations||You can find many web site which focus solely on penny stocks by doing an internet search on “penny stocks”. Visit these sites and make a list of any ten penny stocks. Then:
|A final word||Investing is difficult enough without resorting to putting one’s money in penny stocks.|