Making Money With Stocks
It’s what we’re all here for! The stock market is all about the money, and when diving into any investment, the goal is always to get more out than we put in!
When it comes to stocks, there are two core ways to make money. First, the share price can go up. That can happen for a host of reasons, one being if the company buys its own stock on the stock market! We’ll get to that later… The second way is when the business directly deposits money straight into our bank account, a dividend payment. That cash drip is very welcome, indeed.
An Increasing Share Price
You know someone’s doing well when you see a stock chart that only goes up! A rising stock price is both the most obvious, and the most chased form of wealth creation that investors seek out. Although the gains are all on paper, you can eventually cash in by selling your shares for more than you bought them.
Stocks don’t go up for no reason. A share is a unit of ownership in a business, and it usually entitles us to a share of the money that the business makes. It’s not rocket science!
As the profits mount up for a company, the management team get faced with a pivotal choice. Either, invest it back into the business, or don’t. As long as they put the money to good use, making a comfy profit in the process, choosing the former option will help the stock price rise.
Take Walmart, for example. The market’s finance boffins have done some number crunching, realizing that Walmart keeps much of its earnings within its own business. It reinvests the money into various projects within the company. If the money (our money!) is used to open a new store, hopefully, the market will see a payoff from that store for many years to come.
Cue investors’ expectations to be raised as well, as they decide it might be worth paying a little more for the stock given the new possibility that Walmart will make them more money in the future. So, there you have it, a rising stock price.
Be on your guard, however. The money we expect the business to make us must always have us feeling comfortably compensated for the risk we’re taking with buying the stock. If it doesn’t, then forget reinvesting, we want dividends!
Dividends
While some companies reinvest all their profits, there are still many others who don’t. If the CEO doesn’t see enough opportunities to reinvest or can’t pull any other financial wizardry, there’s always a last resort to fall back on; dividends!
When we receive our share of the profits in dividend form, that means they’re paid directly. Needless to say, dividends are very, very popular! It’s a tangible cash drip that can make for a good source of income over time.
However, if a business is a money-making machine, then no value is created by taking money out of that machine with a dividend. Of course, no value is destroyed either, which could be the case if the company reinvested and arrived at a loss!
Dividends can be raised over time as the business makes more and more money, and are often paid by mature companies. This is because growing companies tend to have more reinvestment opportunities, and not the reliable profits that dividend investors command, anyway. Many dividend investors are planning for retirement and want a safe income!
If there’s a caveat, it’s that dividends are taxable. A common trick is to use a dividend reinvestment plan (DRIP) service that reinvests your dividend income back into the stock. Despite some DRIP services reinvest blindly at any level, and others having quite high costs, reinvesting a dividend has proven a popular way to top-up your holdings.
If dividends sound tempting, check out the dividend aristocrats, champions, and contenders lists. American stocks are ranked on these lists based on how many years they’ve paid or increased their dividends. Onto the next!
When the Company Buys Back its Stock
This is an interesting one. In recent years, it’s become more and more common for CEOs to say, “Hmm, you know what would be a great investment for us? Our own stock!”
Don’t forget that amidst all the bells and whistles of a company’s debut onto the stock exchange, there’s a motive. Insiders are selling a large chunk of ownership of their company to the outside world, and for one reason; raising money! Raising money will allow them to pursue more opportunities for the business, sending the value of their stock up as new investors!
When a company decides to invest its profits back into its own stock, it reabsorbs ownership of itself from the outside world. If you’re lucky enough to be an investor, shares in the stock pool will get drained, leaving yours to be worth even more. Kerching! Share “repurchases” or “buy-backs” do the stock price a great service.
What could be a wiser investor in a company’s stock than the company itself? Just make sure the business isn’t buying back stock at too bubbly a price, as that could end in disaster!
Hopefully, you’re feeling a bit more clued into the mechanics of the stock market now. Whether it be a soaring share price or a bumper dividend haul, if you’re making money, there are no wrong answers. You’re ahead of the game!
