An investor is considering purchasing one of the following three stocks. Stock X

Question

An investor is considering purchasing one of the following three stocks. Stock X has a market capitalization of $6 billion, pays a relatively high dividend with little increase in earnings, and has a P/E ratio of 10. Stock Y has a market capitalization of $61billion but does not currently pay a dividend. Stock Y has a P/E ratio of 37. Stock Z, a housing industry company, has a market capitalization of $802 million and a P/E of 17

a. Classify these stocks according to their market capitalizations.

b. Which of the three would you classify as a growth stock? Why?

c. Which stock would be most appropriate for an aggressive investor?

d. Which stock would be most appropriate for someone seeking a combination of safety and earnings?

Question - Stock X is classified as a____-stock

a. small-cap

b. mid-cap

c. large-cap

Explanation / Answer

a. Classification of stocks on the basis of market capitalization of their companies is based on six categories:

1. Nano cap stocks: Stocks with market capitalization of less than $50 million.

Micro cap stocks: Stocks with market capitalization of $50 million to $2 billion

Small cap stocks: Stocks with market capitalization upto $2 billion

Mid cap stocks: Market capitalization ranging from $2 billion to $10 billion.

Large cap stocks: Market capitalization over $10 billion.

Mega cap stocks: Market capitalization at and over $200 billion.

Based on this classification, Stock X and Stock Z fall under the category of mid cap stocks with market capitalization less than $10 billion. Stock Y is a large cap stock at $61 billion.

b. Mid cap and small cap stocks are considered to have great growth potential than large cap stocks. However, Stock X is paying high dividend with little increase in earning. So it can't be said that X is growing. Stock Y though a large cap stocks is not paying any dividend which means that the stock is still growing. Stock Z, also a mid cap stock at $8 billion market capitalization is also a growth stock.

c. Aggressive investment strategy involves attempts to maximize capital gains by taking a relatively higher degree of risks. Its primary goal is capital appreciation rather than income. Mid cap stocks are considered more volatile than large cap stocks due to their high growth potential. Stock Z also has the lowest EPS at $47.18(802M/17, P/E= MPS/EPS). Therefore investment in Stock Z will be considered as aggressive investing.

d. Stock X though a mid cap stock is paying higher dividends with little earnings. This means it is not a growth stock. Investment in this stock will be a combination of saftey and earnings.

Stock X is classifed as a mid cap stock.

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