When investing, it's good to understand what kinds of companies are out there and what people are talking about when they refer to "cyclical" or "blue-chip" firms. Here are some of the main groups you'll run across.
- "Cyclical" companies react strongly to economic change. Think of it this way: People spend money more conservatively during recessions, putting off major purchases such as cars and refrigerators. Thus, manufacturers of automobiles and large appliances are cyclical. Meanwhile, companies that aren't so affected by the economy are "defensive." An example would be pharmaceutical firms. If you're taking heart medication, you're not going to stop because of an economic downturn. Food is another defensive industry.
- "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. Swimming pool companies see large sales and profits mainly in the summer. And as you might imagine, Dave's Groundhog Emporium (ticker: WDCHK) is also rather seasonal.
- "Blue chip" companies have been around a long time and are perceived as being of higher-than-average quality and lower-than-average risk (though that's not always the case). They're steady growers and usually pay dividends. (The term "blue chip" is derived from poker chips, where the blue chips are the most valuable.) "Red chip" companies are smaller, younger, less proven, and usually riskier. Some examples of blue chip companies: General Electric
(NYSE:GE), ExxonMobil (NYSE:XOM), Merck (NYSE:MRK), Procter & Gamble (NYSE:PG), Walgreen, and Boeing. At the other end of the spectrum are "speculative" stocks, typically tied to young, relatively unknown, and 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. [Bill Mann recently wrote about blue chip companies.]
- "Growth" stocks are growing faster than the market average. They usually pay little or no dividend, as they need any extra cash to fuel their growth. Their stock prices often go up -- and sometimes down -- quickly. Aggressive investors favor growth stocks. Some examples of firms that are or recently have been growth stocks: Microsoft
(NASDAQ:MSFT), Amazon.com (NASDAQ:AMZN), eBay (NASDAQ:EBAY). (Railroad and telegraph businesses were growth companies once -- but things change over time.)
- "Value" stocks are favored by investors looking to buy the proverbial "dollar for fifty cents." They seek companies that are temporarily out of favor. If, for example, restaurant stock prices have dropped as investors lose interest in them, these could be "value plays."
- "Income" stocks may not grow too quickly, but they pay fat dividends. They're sort of like bonds, which pay you interest. Traditionally, utility companies have paid high dividends. Today, some real estate companies do, as well. People in or near retirement, who rely on the dividends to supplement pensions or savings, often favor income stocks.
When evaluating companies, it helps to think of what categories they fall into. Learn these terms and concepts (and drop them in conversation), and you'll be the savviest Fool on your block.
You can learn more about how to interpret financial statements in our "Crack the Code: Read Financial Statements Like a Pro" How-to Guide. Give it a whirl -- what do you have to lose, except your fear of financial statements?
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