What should you consider when you’re looking to buy a specific individual share of stock? Well, it is important not to rely on luck. Sure, luck helps, but there are many factors at play when you decide to become an investor in individual shares.
To be smart, you should have a cursory understanding of the following basics of share investing.
Let’s take a look at the six basic types of shares of publicly traded companies that are available for you to invest in.
1. Growth shares
Growth shares are from companies that reinvest all of their earnings into themselves to facilitate exponential growth. They likely won’t pay a dividend (or may pay a very small one) and are often found in the technology sector.
Some growth companies, especially new ones, won’t create profit for three to five years, or maybe longer. So, the growth of the company and of the share price depends mainly on speculation about what the future company is going to be worth. They have a proven concept that seems to indicate it could grow into a large company, but many times, on paper, these companies are not generating a profit.
Uber, the ride-sharing hyper-growth company, is a good example. Although it has been in business since 2011 and has been a publicly traded company since 2019, it finally hit profit for the first time in its company’s history in 2023.
In 2022, Uber reported a profit on an adjusted EBITDA basis, meaning it had generated positive earnings before interest, taxes, depreciation and so on. However, the company still lost a large sum of real, countable money.
Charlie Munger – who, before his passing, was vice chairman at Berkshire Hathaway – famously said that “every time you [see] the word EBITDA, you should substitute the word ‘bullshit’ earnings”.
2. Cyclical shares
Cyclical shares are from companies that move with the economic and business cycle.
Cyclical companies usually sell products and services that consumers tend to buy more of when the economy is doing well and less of when the economy is doing poorly. Examples include cruise lines, airlines and recreational suppliers.
In 2020, when no-one in the world was flying or going on cruises, these shares plummeted. Yet, in the second quarter earnings of 2023, companies such as American Airlines and Delta Airlines reported record earnings.
And when the world was at a standstill, companies like ARB made a killing with their recreational vehicle sales – but that was most likely a blip in the system rather than a sustainable sales boost.
3. Blue chip shares
These shares are from companies with excellent reputations and brand awareness that have been around a long time, have stable earnings and typically pay a dividend. These are sought after by dividend investors for quarterly or monthly income. Examples include Coca-Cola, Procter & Gamble, BHP Group and Commonwealth Bank of Australia.
Famously, Warren Buffet has been a long-time shareholder of Coca-Cola and has bragged about the company’s stability, brand recognition and, maybe most importantly, its slight growth while paying an attractive dividend.
4. Speculative shares
Speculative shares are from companies with massive potential upsides but just-as-large potential downsides. They are extremely volatile and will add extra risk to your portfolio. If you can handle the risk, consider them. If risk is a scary word to you, stay away.
Examples include EV start-ups – some of which haven’t yet produced a single vehicle – and micro-sized pharmaceutical companies that are working on a breakthrough drug but still have years of governmental testing and approvals to go before they have a marketable drug for the average person to use.
When you buy into one of these companies, you need to be willing to see all your money go to zero, because one government rejection for a new pill or medicine, or a bad quarter, and these companies could run out of money and be bankrupt in days.
5. Defensive shares
Defensive shares are from companies that provide stable and consistent earnings no matter what the overall market is doing. These companies sell products and services that people need 365 days a year, regardless of income level or the economy. Examples include McDonald’s, Woolworths, Verizon and Walmart.
Recession or no recession, people are not going to stop getting their McDonald’s. Life is too hard to not have those French fries in your life. People might drop their Starbucks intake a little bit during a recession, but many will probably still eat at McDonald’s.
6. Dividend shares
Dividend shares are from companies that pay out a portion of their earning to investors so that you, as an investor, can start building cash flow from holding your shares. Examples include AT&T, Realty Income, SmartCentres and Charter Hall CHC.
Investors buy shares from these companies many times over in the hope of reinvesting their dividends to buy more shares and create a snowball effect for their portfolios.
Or they buy shares from these companies hoping for a little bit of upside growth (to beat inflation) while taking a three to five per cent dividend each quarter or month to help pay the bills in retirement.
This is an edited extract from The quick-start guide to investing: Learn how to invest simpler, smarter and sooner by Glen James and Nick Bradley. The book is available at all leading retailers.