Another common way of describing stocks is based on the anticipated performance of the company over time. Here are a few anticipated performance labels placed on stocks:

- Growth stocks: Stocks of relatively new and rapidly expanding companies

- Income stocks: Stocks of established companies that have a history of paying good dividends

- Cyclical stocks: Stocks that rise and fall with the business cycle The labels applied to stocks such as “growth” or “income” refer to the past performance of a stock. So, when a stock is labeled “growth” or “income”, these companies have either been a relatively new or rapidly expanding company in the past or have paid good dividends in the past. These labels are an educated guess of what the stock is likely to do based on looking back at past history but do not offer any guarantee of future results. Here are a few examples of how knowing whether a stock is a growth or an income stock can help you make investment decisions.

- New investors presumably want long-term growth. For example, a young person with years to build up a nest egg, there is little point in investing in a stagnant company with steady but small dividends. A young investor is usually in a position to take greater risks in a growth stock in order to earn greater overall returns.

- Retired investors on the other hand are more likely to seek current income, so they move toward stocks that produce a higher level of current income while maintaining or modestly increasing their value. After retirement when income from employment is no longer available, the mature investor can begin to take dividends in cash rather than reinvesting them in additional shares, making income stocks a good choice. You may wonder who would want to buy cyclical stocks which rise in good economic times and fall back in times of recession or depression. Knowing that a stock is cyclical provides useful clues about how the stock will likely perform. If you’re inclined to try to maximize your return by buying low and selling high, you may have a strong interest in the cyclicals. You buy them when you think the economy is about to come out of recession or depression, and you sell them when you think the economy is peaking. This article does not recommend an investment program based on constantly trading cyclical stocks. Any strategy that calls for constant trading carries high risks along with possible higher gains. You should know, however, which stocks are more likely to fluctuate with the business cycle so that you don’t mistakenly buy them in good economic times and sustain heavy losses in even mild recessions.

Industry Group

Industry group is another categorization of stocks. An industry group is a way of lumping like businesses together. For example, all Internet stocks, computer hardware manufacturers and software producers can be grouped together as technology stocks. These categories are helpful if you’re seeking to diversify your stock investments. Diversification putting your eggs in more than one basket is a recommended approach to reducing the risk of relying on the performance of stock in one company or industry (something I’ll return to in Chapter 8). For example, having all your investments in one category, like technology stocks, is probably not a good idea because if the entire market takes a downturn, then all your investments will be affected negatively. The industry groups designated by the Dow Jones Corporation (publisher of The Wall Street Journal and many other financial-related publications) are the following:

- Basic materials (mostly metals)

- Conglomerates

- Consumer/Cyclical (includes companies that provide products and services that vary with economic good and bad times)

- Consumer/Noncyclical (includes basics like food, medicine, and tobacco)

- Energy (coal and oil)

- Financial (banks and insurance)

- Industrial

- Technology (generally high-tech but also includes biotechnology) Analysts have devoted years of study to determine how different businesses perform. For example, pharmaceutical companies have produced consistently high returns on investment over the years. Basic consumer goods such as food have much lower profitability. Stocks are also commonly analyzed by comparing them in terms of growth, earnings, and volatility with other companies in the same category. A familiarity with these terms can help you translate the financial pages of your favorite newspaper and sort through the data involved in the process of selecting a few stocks for investment. To better understand the practical application of industry group categories on the real world of investing, buy a copy of Investor’s Business Daily and check out its SmartSelect Corporate Ratings. These ratings include an Industry Group Relative Strength Rating, which tells how any stock ranks in terms of price compared to other stocks in the same industry group. This rating can help you figure out whether a particular stock is a strong performer compared to others in the same industry.