How Investors Make Money#

Now that you understand what stocks are and how they're categorized, the big question remains: how do you actually make money from owning them? There are two primary ways investors profit from stocks.

Method 1: Dividends#

A dividend is a portion of a company's profits distributed to shareholders. Think of it as getting paid for being a part-owner.

How Dividends Work#

1. Company earns profit during a quarter or year
2. Board of directors decides to distribute some profit to shareholders
3. Shareholders receive a cash payment per share they own
4. Most dividends are paid quarterly (4 times per year)

Example Calculation#

Let's say you own 100 shares of a company that pays a $0.50 quarterly dividend:

• Per quarter: 100 shares × $0.50 = $50
• Per year: $50 × 4 quarters = $200 in dividend income

Dividend Yield#

The dividend yield tells you how much income a stock generates relative to its price:

Dividend Yield = Annual Dividend ÷ Stock Price × 100%

If a stock costs $100 and pays $4 per year in dividends:

• Dividend Yield = $4 ÷ $100 × 100% = 4%

Important Notes on Dividends#

• Not guaranteed: Companies can reduce or eliminate dividends
• Not all companies pay them: Growth companies often reinvest instead
• Taxable: Dividend income is typically taxable (though rates vary)

Method 2: Capital Gains#

Capital gains occur when you sell a stock for more than you paid. This is how most investors think about "making money" in the stock market.

How Capital Gains Work#

1. You buy shares at one price (your "cost basis")
2. The stock price increases over time
3. You sell the shares at the higher price
4. The difference is your capital gain

Example Calculation#

You buy 50 shares at $40 each, then sell them at $60:

• Cost basis: 50 × $40 = $2,000
• Sale proceeds: 50 × $60 = $3,000
• Capital gain: $3,000 - $2,000 = $1,000 (50% return)

Unrealized vs. Realized Gains#

Total Return: The Complete Picture#

Total return combines both sources of investment profit:

Total Return = Dividends Received + Capital Gains (or Losses)

Example: Full Picture#

You invest $10,000 in a stock and hold it for one year:

• Dividends received: $300
• Stock price change: Up 8% ($800 gain)
• Total return: $300 + $800 = $1,100 (11% total return)

This is why two stocks with the same price appreciation can have different total returns, the one paying dividends provides extra value.

The Power of Compound Growth#

One of the most powerful concepts in investing is compound growth: earning returns on your returns.

How Compounding Works#

If you invest $10,000 with a 10% annual return:

Dividend Reinvestment#

You can supercharge compounding by reinvesting your dividends to buy more shares. Many brokerages offer automatic dividend reinvestment programs (DRIPs).

Instead of receiving $300 in cash, those dividends buy more shares, which then generate their own dividends, creating a snowball effect.

Which Strategy Is Right for You?#

The balance between dividend income and capital appreciation depends on your goals:

Many successful investors pursue a blend of both strategies, building a diversified portfolio that provides some income while also positioning for long-term growth.