Stocks are grouped into categories based on various criteria such as the company's industry or sector, its market cap, growth prospects and earnings. Two commonly referenced types of stock are "blue chip" and "microcap." Blue chip stocks represent some of the largest and most prestigious companies in America, while microcap stocks represent the smallest companies and the riskiest investments. Blue chip and microcap companies react differently to economic events. Investors must know the risks and rewards of both types of stock to formulate intelligent and successful investment strategies.
Blue Chip Characteristics
Blue chip stocks represent large, successful corporations with stable financial histories, strong balance sheets and, often, a history of paying dividends. The market capitalization of blue chip companies is usually greater than $15 billion. The Dow Jones Industrial Average includes many of the leading blue chip stocks. These stocks can be purchased through full-service and discount brokerage firms. In addition, many blue chip companies permit investors to purchase stocks directly via a dividend reinvestment plan, which circumvents broker transaction fees.
Pros and Cons of Blue Chips
An advantage of investing in blue chip stocks is that you are investing in successful and financially sound corporations. This typically means that you don't need to worry about these companies going bankrupt. Most blue chip stocks pay dividends, which is beneficial for investors seeking extra income or desiring to reinvest dividends to purchase additional shares. A disadvantage of investing in blue chips is that investors usually receive modest returns on their investment. Generally, the less risky the asset, the lower the potential returns.
According to the Securities and Exchange Commission, microcap stocks usually represent companies with very low market capitalization, often between $1.25 million and $6 million. Microcap stocks are not included on the Dow Jones or S&P; 500 indexes. Often, these stocks are listed on the Over-the-Counter (OTC) Bulletin Board or the Pink Sheets. Investors may have difficulty finding public information about microcap companies, which means the stocks are extremely speculative.
Pros and Cons of Microcaps
The advantage of investing in microcap stocks is the potential for high returns. Microcap stocks usually trade for just a few dollars (or cents) per share, so when the value of the shares rise, investors may earn big returns. One disadvantage of investing in microcaps is that they are extremely risky. Investors may have difficulty researching these smaller companies; many lack a proven financial track record and are still in the development stage. Another disadvantage is that over-the-counter markets do not require companies to meet the same stringent financial requirements as the major market indexes, which results financially unstable companies being listed.
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