As the economy evolves, certain areas expand faster than average while others dwindle. Which would you consider the technology sector? It’s growing rapidly, of course. Corporations that compete in these sectors must emerge as one of the leaders because markets only have room for a few companies. What do we mean? Can you name the number 3 Internet search engine? The third most popular cell phone operating system?

So, how do corporations give themselves the best chance to emerge and maintain their positions as leaders in expanding markets? They often “plow back” any 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.

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.

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 brand recognition, market share, financial strength,  and solid management to grow steadily and continue dominating their markets.

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. It’s unlikely that people will go to an alternating-day schedule of showering and tooth-brushing to save money if the economy is not doing well. They will instead find other ways to conserve.

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.

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.

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.

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 a Harvard classmate named … Mark Zuckerberg.

As times change and technology advances, new industries and opportunities regularly arise. Examples from the last few decades include the Internet, wireless communications, smart phones, GPS mapping and clean energy.

When a new market opens, some corporations, often small and young, quickly dive into the void in the hopes of growing right along with the new market and eventually emerging as the leader. As a result, we call them emerging growth stocks. It should go without saying that these corporations reinvest any profits to grow the business as fast as possible.

Because they often start off very small, these corporations may be able to ride the new market’s growth and double, triple or quadruple themselves in a short period of time. The value of your stock may do the same! But, it’s much more likely that one or both of the following plays out:

1. the corporation is swamped with an array of similar competitors and just cannot gain enough market share to sustain itself
2. the emerging market never, well, emerges. That is, the exploding demand that experts predicted never materializes. Recent history is replete with technologies that were supposed to be the next big thing but which simply fizzled. They include personal 3D printers, fitness wearables, action cameras, consumer drones and virtual reality headsets.

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 can make a tremendous amount of money. If it doesn’t, your entire investment will probably be lost. These companies need every penny (no pun intended) people invest in them, so they do not pay dividends. In fact, they may never have made a profit.

There are other concerns with penny stocks:

• With a low value and infrequent trading, 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.
• the financial condition of these corporations is often weak, meanig that they cannot sustain losses as larger, better capitalized corporations can.