|stock profit strategy- How Do Stocks Make You Money?|
Whether you follow the financial ecosystem or not, you would surely have heard of stocks and the stock market. You must have also wondered how do stocks make you money. While a lot of Bollywood and Hollywood movies show you how traders and investors make fortunes from stocks, they don’t actually show you how this is done. If you have been looking for answers to all your stock queries, this is the right place for you. In layman terms, a stock is a security which represents a fractional ownership of the issuing company. Stocks are issued by companies in an attempt to raise funds to ensure optimal operations. It may also be a means of diluting the promoter’s stake in the company.
For instance, if you purchase stocks of Zomato, it indicates that you own a fraction of the company and are, therefore, entitled to a part of the company’s profits. Stocks are also known as equities and units of stocks are known as shares. Stocks are largely traded on stock exchanges and form a large part of the portfolio of high risk investors who are keen on earning high returns. Trades on the stock exchange are facilitated through a demat account and traders and investors are required to comply with government regulations and norms aimed at protecting investors from fraud.
How do stocks make you money?
Now that you know what a stock is, let us take a look at how do stocks make you money. There are two major sources of returns, which are dividends and capital appreciation. Historically, stocks are known to have outperformed other assets such as gold and debt and, in line with the high returns, investors also have to contend with heightened risk. You can earn profits from stocks based on the number of shares you own, and the total outstanding shares of the company. For instance, you invest in company X, which has 1000 total outstanding shares. If you purchase 10 shares, it means that you would have a right to 1% of the company’s assets and earnings. Let us consider the two ways by which you can make money from stocks.
Dividends refer to the cash distributions of the company’s profits. Going back to the previous example, if the company X, in which you have 1% ownership, declared a dividend of 50,000 rupees, you would earn 500 rupees as dividend income, basis the 10 shares you own. Dividends can be a source of income for investors who purchase shares of companies which routinely offer shareholders a portion of the profit, in the form of dividends. Most dividend-paying companies pay dividends on a quarterly basis, but some may choose to pay it annually or even on a monthly basis. If you had purchased the shares of companies like HDFC or Tata Steel in the recent past, chances are that you would have seen an amount being credited to your account after the quarterly result of the company. This amount, which is your share of the profits earned by the company in the last quarter, is known as dividend. Therefore, one of the answers to the question how do stocks make you money is dividend income.
The second way of making money from stocks is capital appreciation. Considering the example of company X, in which you currently hold 10 shares, let us see how you can make money from capital appreciation. Suppose you purchased the 10 shares for a price of 50 rupees each, one year ago. Today, the shares are worth 65 rupees a piece, indicating a nominal profit of 150 rupees on the entire holding. This is the principle behind capital appreciation. Most stocks, as long as they are issued by fundamentally strong companies, end up showing capital appreciation over a period of time. Therefore, when you then sell the stocks, you will end up earning profit in line with the capital appreciation.
Now that you know the two different ways in which you can make money from stocks, let us consider which option is best suited for you. If you are an investor who is keen on earning a regular income from stocks, instead of earning a one-time profit when selling off your holdings, you should consider investing in companies which offer you regular dividends. However, if you are keen on investing in a growing company which is expanding quickly and offering strong capital appreciation, then you can invest in companies which pump in their profits to boost their business lines, instead of paying dividends.
Remember, whichever type of stock you choose, you will always face an amount of risk. In fact, the greater the risk, the higher is the potential for return, as long as the company has a sound structure. So, now that you know the answer to how do stocks make you money, you can decide whether or not to try out the avenue.
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