Nothing could be further from the truth. It's certainly not how I run my own portfolio nor the portfolios that we control at my family's asset management company.
That is the way real wealth is built in the stock market for outside, passive investors. Still, many new investors don't understand the actual mechanics behind making money from stocks; where the wealth actually originates or how the entire process works.
When you buy a share of stock , you are buying a piece of a company. Introduction to Wall Street. This figure is known as Basic EPS short for earnings per share. In other words, when you buy a share of Harrison Fudge Company, you are buying the right to your pro-rata profits. If you thought that a new management could cause fudge sales to explode so that your pro-rata profits would be 5x higher in a few years, then this would be an extremely attractive investment.
Instead, management and the Board of Directors have a few options available to them, which will determine the success of your holdings to a large degree:. Which is best for you as an owner? That depends entirely on the rate of return management can earn by reinvesting your money. If you have a phenomenal business — think Microsoft or Wal-Mart in the early days when they were both a tiny fraction of their current size - paying out any cash dividend is likely to be a mistake because those funds could be reinvested at a high rate.
Those kinds of returns typically only exist in fairy tales yet, under the direction of Sam Walton , the Bentonville-based retailer was able to pull it off and make a lot of associates, truck drivers, and outside shareholders rich in the process.
Berkshire Hathaway pays out no cash dividends while U. Despite these differences, they both have the potential to be very attractive holdings at the right price and particularly if you pay attention to asset placement provided they trade at the right price; e. Occasionally, during market bubbles, you may have the opportunity to make a profit by selling to someone for more than the company is worth. The Balance does not provide tax, investment, or financial services and advice.
The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors.
Past performance is not indicative of future results. Investing involves risk including the possible loss of principal. Updated September 11, Instead, management and the Board of Directors have a few options available to them, which will determine the success of your holdings to a large degree: It can send you a cash dividend for some portion or the entirety of your profit. It can repurchase shares on the open market and destroy them. For a great explanation of how this can make you very, very rich in the long-run, read Stock Buy Backs: The Golden Egg of Shareholder Value.
It can reinvest the funds into future growth by building more factories, stores, hiring more employees, increasing advertising, or any number of additional capital expenditures that are expected to increase profits. Sometimes, this may include seeking out acquisitions and mergers. It can strengthen the balance sheet by reducing debt or building up liquid assets. An increase in share price. Over the long-term, this is the result of the market valuing the increased profits as a result of expansion in the business or share repurchases , which make each share represent greater ownership in the business.
When earnings are paid out to you in the form of dividends, you actually receive cash via a check in the mail, a direct deposit into your brokerage account , checking account, or savings account, or in the form of additional shares reinvested on your behalf.
Alternatively, you can donate, spend, or pile these dividends up in cash.More...