What's a Blue Chip, Anyway?

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Before you start investing, get to know the lay of the land. Here's a quick guide to the most common species of companies roaming around the Wall Street jungle:

• Cyclical companies react strongly to economic change. For example, people spend money more conservatively during recessions, delaying major purchases such as cars and refrigerators. Thus, manufacturers of automobiles and large appliances are cyclical.
  
  
• Defensive companies are the opposite of their cyclical brethren. They provide products that people will continue to need despite economic ups and downs, including food and medicine.
  
  
• Seasonal companies experience significantly different levels of business at various times of the year. Department stores, for example, see sales surge during the Christmas holiday season, while swimming-pool companies enjoy their greatest sales and profits in the summer.
  
  
• Blue-chip companies are durable, long-established companies with a reputation for higher quality and lower risk than the average firm -- though that's not always the case in reality. They're steady growers, and they usually pay dividends. The term "blue chip" is derived from poker, where the blue chips are the most valuable. Classic blue-chip companies include General Dynamics (NYSE: GD), ExxonMobil (NYSE: XOM), and Merck (NYSE: MRK).
  
  
• Red-chip companies are smaller, younger, less proven, and usually riskier than blue chips.
  
  
• Speculative stocks occupy the opposite end of the investing spectrum from blue chips. They're typically tied to young, relatively unknown, risky companies. Many promise great things, but have yet to prove themselves. Examples might include gold mines, or companies trying to develop cures for cancer.
  
  
• Growth stocks are growing faster than the market average. They usually pay little or no dividend, since they need any extra cash to fuel their growth. Their stock prices often rise -- or fall -- quickly, making growth stocks a favorite of aggressive investors. Microsoft, Amazon.com, and eBay were growth stocks in the heyday of the Internet boom, as were railroad and telegraph businesses in earlier eras.
  
  
• Value stocks are favored by investors seeking temporarily out-of-favor companies in hopes of buying the proverbial dollar for $0.50. The market often overestimates the effect of one company's bad news on its entire sector, or simply loses interest in an otherwise sterling company or industry. That's when value investors swoop in to buy these value stocks, hoping that they'll eventually return to their actual worth.
  
  
• Income stocks may not grow too quickly, but they pay fat dividends. Like interest-paying bonds, they offer a steady stream of income for their shareholders. Traditionally, utility companies have paid high dividends; today, some real estate companies do so, too. People in or near retirement often favor income stocks, relying on their dividends to supplement pensions or savings.

Learn these terms and concepts (and drop them in conversation), and you'll be the savviest Fool on your block.

Longtime Fool contributor Selena Maranjian owns shares of Microsoft, a Motley Fool Inside Value pick, and eBay and Amazon.com, both Stock Advisor selections. The Fool has a disclosure policy.