Investing Terms Made Easy For You – Part 1

If this is your first time reading an investment column, it can be quite vexing. In fact, it can get vexing even after the umpteenth time! There’s just so many different terms and jargon used in finance and investing that it can confuse anyone. To help out with that, here’s a short, quick guide to some commonly-used terms to help unravel some of that confusion.

What does “Cyclical” and “Defensive” mean?

Cyclical stocks are basically companies that sell products or services that are deemed to be discretionary purchases for consumers (i.e. consumers have a choice not to purchase these products or services). This means that in a time when the economy slows down and consumers cut back on spending, these products or services are likely to be the first ones that people reduce their spending on.

For instance, companies such as the full-service carrier Singapore Airlines (SGX: C6L) and luxury fashion retailer FJ Benjamin (SGX: F10) can be seen as cyclical companies. This is because consumers tend to travel less with premium carriers or buy upmarket clothing during recessions.

Defensive companies on the other hand, generate relatively stable earnings even throughout the whole boom and bust of an economic cycle. Companies like supermarket retailer Dairy Farm International (SGX: D01) and telecommunications operator Starhub (SGX: CC3) are examples of defensive companies given that the demand for their products – items that are consumed daily for the former and telecommunication services for the latter – are mostly stable all the time.

What are “Blue Chips” and “Penny Stocks”?

Blue chip” is a term stolen from the poker table. In a game of poker, chips are used to represent cash and as it turns out, chips that are blue in colour are usually meant to represent the largest dollar-denomination in the game. As such, the term “Blue chip” is now typically meant to symbolise the largest companies that are listed in any country’s stock exchanges.

In Singapore’s stock market, all 30 components of the Straits Times Index (STI: ^STI) can be considered as blue chip companies. Though, it should be noted that for all the positive connotations that the term “blue chip” brings to a stock, investing in a blue chip can still be a risky affair at times.

After the blue chips, come the “penny stocks”, which resides on the other end of the scale, where companies that are less well known and have a very small market capitalisation are found. Typically, these shares are trading below a dollar, hence the term “penny stock”.

After their infamous crash last year, Blumont Group (SGX: A33), Asiasons Capital (SGX: 5ET), and LionGold Corp (SGX: A78) are now sometimes used as examples to embody the risks involved with investing in penny stocks, though it’s not always the case where penny stocks are riskier types of investments as compared to blue chips.

Foolish Conclusion

There are many terms available to describe or to group together individual publicly-listed companies.

It is worth noting that the terms described above (and for most other terms used in the investing world, for the matter) are not mutually exclusive, meaning to say that a company can be both a defensive stock and a blue chip stock, or be both a cyclical stock and a blue chip stock, or be in any other combinations you can think of.

Furthermore, as with all businesses, the classification is dynamic and a company can switch from one group to another as it grows and changes its business model.

For instance, Genting Singapore (SGX: G13) could have been be classified as a penny stock a decade ago when its flagship integrated resort Resorts World Sentosa had not been built or even had its plans finalised yet. Now, with RWS operating smoothly and generating good returns for shareholders, Genting Singapore can be considered as one of the blue chips in Singapore. That’s all the more so given its status as one of the 30 companies within the Straits Times Index.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.