PostHeaderIcon How to Make Money on Stock

It has been baffling to us, especially those who have no idea about stocks and other related forms of investment, how those stockholders actually earn from their stocks. Yes, we know it gets traded, but what how richer are we if we have, say, 100 shares of Gunther Coffee, Inc?

In reality, earning money through stocks is pretty easy. Let’s learn the basics before we delve into the more intricate aspects of stock trading.

Buying a share of stock is actually buying a piece of the company. For instance, Gunther Coffee, Inc. (a fictional business) has sales of $20,000,000 and net income of $12,000,000. In order for the organization to raise money for their planned expansion, the company’s owners would approach an underwriting firm (an investment banker) and had them sell stock to the public. The underwriters then assess the company’s financial standings as well as how the coffee industry fares in the market to measure how much the company is worth.

Let’s say that the underwriters determined that the company is worth $55,000,000. The company owners much then decided how much of the company they are will to sell to the public. In this case, they company’s founders decided that they would keep 60% of the company and sell the remaining 40% to the public as stock.

This means that they get to keep $33,000,000 worth of the company while selling the remaining $22,000,000 as stocks. The underwriters then determine how to sell the stocks, for instance how much per share. They advised that it’s best that the share be sold a $11 each while cutting the company’s 40% into 2,000,000 shares of stock.

Note: 2,000,000 shares x $11 = $22,000,000

This means that each share of stock is entitles to $6 of the profit. This figure is known as "Basic Earnings Per Share."

Note: $12,000,000 profit ÷ 2,000,000 shares = $6

This means, when you buy a share of Gunther Coffee, Inc., you are actually buying the right to your pro-rata profits. Buying 100 shares for $1,100 means that you would be buying $600 in annual profits plus any other future growth (or losses) the company would generate.

Although earning money through stocks is easy, how to get it is a little complicated. The company’s management and the Board of Directors would have to determine how to payout their shareholders, which in a way determine the success of your holdings.

First option is for the company to send you a cash dividend of your profit, in part or full. This is one way for the company to return capital to their shareholders. You could either use this cash to buy more shares or go spend it as you please.

Another option is for them to repurchase shares on the open market and destroy them. This is usually done by companies who did not perform well the previous year. For instance, Gunther Coffee, Inc. realized that they sold the same amount of coffee like last year, meaning they have 0% growth. To make up for the loss, the company decides to buy back some of their own stocks, wherein they buy 1,000,000 shares for $11,000,000 then immediately bring these shares to the Board of Directors, where they vote to destroy them so that they no longer exist, thereby having 1,000,000 shares remaining. The good side here is that your 100 shares of Gunther Coffee, Inc. is now worth $1,650, an astounding 50% increase, making your shares more valuable and owning a bigger percentage of equity in the company (from 0.005% to 0.01%).

They can also reinvest the funds into future growth by building more factories, stores, hiring more employees, increasing advertising, or any additional capital expenditures that are expected to increase profits. This may also include acquisitions and mergers.

The company could also strengthen the balance sheet by reducing debt or building up liquid assets.

With these information at hand, we now begin to understand how your wealth is built. There are two distinct ways for this, one of which is through an increase in share price over the long-term. The other is through dividends, where the earnings are paid to you and become your property. You can use the dividends to buy more stocks or spend them how you like it.

Also, there would be times that you may earn from your stocks through selling them, especially during the "down" times. In the end, your returns rely solely on how the company that you own in stock performs.


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