How Is Money Made With Stocks?
Money can be made in stocks in a number of ways, from stock distributions to a rise in the value of the shares. While dividends are announced in advance and can be relatively predictable, making money based on capital appreciation takes analysis and an understanding of the underlying business. Unpredictable factors that are not specific to individual companies can also affect stock prices.
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Stocks
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Stocks represent ownership shares in a company and are known as equity investments. The more shares you purchase, the more your percentage ownership of the company increases. Share ownership exposes you to both the gains and losses of the underlying company, in the form of dividends and capital appreciation or depreciation.
Stock Market
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The stock market is the generic term for the trading activity of the shares of all publicly traded companies. While the fortunes of an individual company may have the most bearing on the performance of the company's stock, factors that affect the stock market as a whole affect individual stocks as well. Thus, even a company with good earnings and financial prospects may not perform as expected due to factors influencing the market as a whole.
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Dividends
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Some companies, usually large multi-national firms, choose to pay out some of their profits to investors in the form of dividends. Dividends are quarterly income payments that make stocks more attractive to investors looking for income as an investment objective. Generally speaking, stocks with larger dividends are less volatile than stocks that pay no dividend, as a company must have a strong, predictable revenue stream in order to pay a regular dividend. Stocks that pay high dividends are often referred to as income stocks.
Capital Appreciation
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Many investors are attracted to the stock market based on the potential for capital appreciation. All stocks trade based on supply and demand, and strong corporate performance increases demand for a stock. If there are more buyers than sellers, the stock price will rise. Many factors can increase demand for a stock, including unexpected positive earnings news, increases in analyst expectations, signing of new contracts or new business, or dividend increases. If you buy a stock before any of these events and the market moves your stock higher, you have a capital gain. When you sell your stock at a gain, you have tangibly made money on your stock.
External Factors
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In addition to internal corporate factors, external events can also rapidly increase stock prices. If a company announces its intention to buy out another company, the target company's stock usually jumps dramatically. If new governmental legislation favors a particular industry or company, those stocks also will rise. Sometimes, market sentiment itself is enough to move stocks higher. In a "bull market" or sustained period of rising prices, even bad news is often not enough to prevent stocks from going higher.
Derivatives
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Derivatives, such as stock options, are a way to make money on stocks without actually owning stocks. Options are a type of derivative because they derive their price based on the movement of another security, in this instance stocks. Options and other derivatives can make large gains based on smaller investments, but they also carry a higher level of risk and should only be used by experienced investors.
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References
- Photo Credit stock shares image by Bruce Shippee from Fotolia.com
