Portfolio Construction - 6 Stock Types

While there are several ways to construct an equity or stock portfolio, we think a focus on the six (6) different types of stocks is critical to providing a foundation that balances expected risk and return in a way that aligns strategically with your financial needs, objectives and investing time horizon. The six types of stocks are (1) Blue Chip Stocks, (2) Dividend Stocks, (3) Growth Stocks, (4) Value Stocks, (5) Cyclical Stocks and (6) Defensive Stocks. A broad approach to asset selection, like this, allows for adjustment of the composition of the portfolio over time, increasing exposure to those assets most likely to outperform in prevailing economic or market conditions. 

Blue Chip Stocks are a must for any investment portfolio, from the most conservative to the most aggressive. Blue Chip companies offer size, strength, industry leadership, diversified business lines, little debt and stability. Many have long established histories of strong earnings and proven track records in the manufacture and/or sale of some of our most iconic American brands. As market leaders, they often experience a slower, yet more predictable growth trajectory. Dividend Stocks not only provide income during periods of declining equity markets, they also tend to smooth out portfolio volatility as they often have a beta (β) under 1.0. When a company pays a dividend, it is returning a portion of its profits to shareholders. Investors often view dividends as both a reflection of the company’s past performance as well as its potential for future growth. The ability to increase its dividend payments is often viewed as a reliable indicator of a company’s financial health and stability. Companies that consistently grow their dividends often exhibit strong fundamentals, clearly communicated business plans and a firm commitment to their shareholders. 

With Value Stocks we are looking for a bargain – stocks that are inexpensive relative to their fundamental value. Value investing targets companies with lower-than-average growth rates for sales and earnings and lower-than-average price-to-earnings (P/E) and price-to-book (P/B) ratios. Typically, Value Stocks are associated with large, well-established companies that tend to trade at a lower price relative to their fundamentals and pay a rich dividend. Investors buy these stocks in the hope that they will increase in value when the broader market recognizes their full potential. With value stocks, we are often looking at disappointing past results. In contrast, Growth Stocks point to a promising future, with less attention paid to past results.  Growth investing targets higher-than-average growth rates for sales and earnings and higher-than-average P/E and P/B ratios.  Most Growth Stocks are more volatile than Value Stocks and pay out less in dividends. The trade-off for dividend hungry investors is that growth-oriented companies are more likely to reinvest profits in the building or expanding of their business thus creating greater value in the ongoing enterprise and lifting share prices.

A typical economic cycle has four (4) distinct phases: Early (rebounding economy), Mid (economic growth peaks), Late (growth moderates) and Recession. Cyclical Stocks (Consumer Discretionary, Financials, Industrials, Materials and Technology sectors) are closely tied to the health of the overall economy and tend to outperform in the first three stages but often experience declining earnings during recessions and other challenging economic times. Share prices of Cyclical Stocks follow the path of the economic cycle, often rising in the Early, Mid and Late Phases only to retreat in Recession.  Defensive Stocks are associated with companies that provide goods and services that consumers demand regardless of conditions, such as groceries, utilities and healthcare. Share prices of Defensive Stocks tend to hold steady or may even rise during economic downturns, making them a good choice for risk-adverse investors.