How to make money with stocks?
In this section, we will explain the two main ways to make money with stocks. How To Make Money with Stocks
There are many strategies to make money by buying and selling stocks; but, for now, we will focus on the two main ways to make money with stocks:
1. Capital Appreciation: Buy Low / Sell High
This is the most talked-about and studied way to make money with stocks. The concept is simple, you generally want to sell a stock for a higher price than what you paid for it. We will look at an example:
Last year, John bought 10 shares of SmartPies Co. at $10 each share, which is a total of $100 invested (10 shares x $10 each). Today, John sells his 10 shares for $15 each, or $150 in total (10 shares x $15 each). John has made a profit of $50 by selling the stock.
Last year: $10 each share x 10 shares = $100 initial investment
Today: $15 each share x 10 shares = $150 current value
Capital Appreciation: $150 current value – $100 initial investment = $50 profit
John’s investment yielded a return of 50% over the holding period of 1 year:
Return: ( $150 current value – $100 initial investment ) / $100 initial investment = 50% return
2. Dividends: Earnings Distribution
This way is really important because it often provides investors with a stream of steady income. A dividend is the distribution of a portion of a companies earnings that is determined by a company’s board of directors and must be approved by shareholders. Dividends can be looked at as a reward for holding a company’s stock and helping them grow. Let’s follow John’s example to drive the point home:
SmartPies Co. offered a dividend of $0.50 per share every quarter (every 3 months). John, who had bought 10 shares of SmartPies Co. would receive $5 every 3 months just for holding the stock.
Year-end Total Dividend: $5 dividends x 4 quarters = $20 dividend
1st Quarter: 10 shares John owned x $0.50 dividend per share = $5 dividends
2nd Quarter: 10 shares John owned x $0.50 dividend per share = $5 dividends
3rd Quarter: 10 shares John owned x $0.50 dividend per share = $5 dividends
4th Quarter: 10 shares John owned x $0.50 dividend per share = $5 dividends
Generally, mature, large companies that have been established for a long time tend to give more of their earnings back to shareholders in the form of dividends, since they don’t need to grow as much and have a bigger cash base. On the other hand, startups tend to reinvest most of their earnings back into the business to fuel the fast growth they need, so they don’t give out as much in dividends.
Both options are valid. Investors are typically compensated regardless of the way the company uses: if earnings are reinvested its earnings back into the business for growth purposes, the price of the stock normally should go up, making the investor’s capital appreciate (way #1); if the company decides to give its earnings to investors in the form of dividends, investors will receive a steady flow of cash periodically (way #2).
Let’s see how all this looks like graphically:
In the above graph, the Stock Price of this company (the blue line) grew significantly, but its Dividend payout (the orange columns) was minuscule and so was its growth. This company was most likely a young, technology-focused company; and its strategy is to reinvest most of its earnings into its operations to maximize the growth of its stock.
High Dividend Yield Stocks
In the above graph, the Stock Price of the company (the blue line) grew at a slower pace, but its Dividend payout (the orange columns) was much greater and so was its growth. This company was most likely a more mature, utility company -for instance; and its strategy is to distribute a big portion of its earnings to its investors, who generally seek stable income streams.
When investing in stocks, it is important to have a set strategy. Typically, the more aggressive investors will focus on growth stocks because they normally have really high capital appreciation levels but low dividend payouts. Conservative investors tend to seek stocks that offer high dividend yields (money paid in the form of dividends) and lower capital appreciation, which generally offers a more stable income.
Next, we will see what bonds are and how to make money trading them. In future sections, we will dig deeper into the stock investing strategies.