Questions You Were Afraid to Ask #16

The only bad question is the one left unasked. That’s the premise behind many of our posts. Each covers a different investment-related question that many people have but are afraid to ask.

In recent posts, we’ve been breaking down some of the more common bits of financial jargon that you are likely to hear in the media about the stock market.  In this message, let’s look at: 

Questions You Were Afraid to Ask #16:
What do terms like blue-chip, value, and growth stocks mean?

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If you ever tune into the financial media, you’re likely to encounter terms for different types of stocks.  Blue-chip is a frequent one; so are value and growth.  But what do these terms mean? 

Terms like these are a kind of shorthand description of a stock’s size, history, or risk profile.   With a single word, experienced investors can learn a lot about a company’s size, potential, and risks.  And since every investor has different goals to consider when selecting their investments, some may choose to focus on one type of stock over another.   

Let’s break down each term so you know what they mean if you ever hear them mentioned. 

Blue-Chip Stocks. This term refers to stocks from large, financially stable companies with good reputations.  (The name comes from high-valued chips in poker, which are often blue in color.) 

Typically, these companies have a sizeable market capitalization. (As you may remember from my last “Questions” letter, this is the total market value of a company’s available shares of stock.)  Blue-chip stocks are often household names that everyone would recognize.  If you look at the credit card in your wallet, the soda in your fridge, or the labels in your medicine cabinet, you will likely see examples of blue-chip companies. 

Investors often prefer blue chip stocks for a variety of reasons.  First, because these companies are well-established, they are often seen as less volatile.  While not guaranteed, blue chip companies tend to last for decades and can often weather recessions. 

Another reason many investors like blue chip companies is because they often pay regular dividends.  A dividend is when a company pays a percentage of their profits to shareholders, usually on a quarterly basis.  These dividends can either be reinvested or used as a source of income. 

Value Stocks. Imagine there were two fine dining restaurants in your area.  One is famous— the kind of place that gets mentioned in travel guides and where people go to propose.  The other, located a few blocks away, is a tiny spot that hardly anyone knows about.  But it tastes just as good as the touristy place, and best of all, it’s so much cheaper.  So, you decide to go there more often than not, aiming to enjoy it for as long as you can before the word gets out. 

Value stocks are similar.  The term refers to companies that appear to be undervalued — meaning they are trading at a lower price than they’re potentially worth.  Investors looking for value usually focus on companies with experienced leadership, steady revenue, a strong competitive advantage, and a low share price relative to their earnings.

Value stocks aren’t always easy to find, and the very concept of “value” is a subjective one.  But the idea is to find companies that could give you great bang for your buck and the potential for long-term growth.  Because, like that neighborhood restaurant, once the word gets out and the stock gets more popular, it could rise significantly in price. Of course, the risk of a value stock is that it could stay “undervalued” for a long time.

Growth Stocks. This term refers to stocks that have the potential to skyrocket in price over time.  Often, growth stocks are younger companies seeking to set new trends or shake up an industry.  These companies focus on growing rapidly and reinvest their earnings entirely into expansion.  Since technology is constantly changing, many investors look to up-and-coming tech companies for growth stocks, hoping to score the “next” Apple or Microsoft. 

But with this potential for growth comes the potential for more volatility.  Growth companies are often much riskier than value or blue-chip stocks, because they are younger, unproven, and have less stable finances.  For every growth company that succeeds and matures, there may be a handful that fail and disappear.

As you can see, each of these types have their own pros and cons. Blue chips tend to be reliable, stable, and often pay dividends — but they can be expensive and their potential for growth may be limited.  Value stocks have the potential to grow, and are typically not as risky as growth stocks, but may be hard to find.  Growth stocks could have the highest upside, but also the most risk and volatility.  For these reasons, many investors often seek to diversify by holding all three types, depending on their specific needs and goals. 

In our next post, we will look at a few other terms you’ll often hear in the media: Dividends, buybacks, and stock splits.  Until next time!