How to Make Money from Shares

There are basically two ways to make money from stocks/shares.

Capital Gains

If you buy a share and over time its value increases because the company grows in size and profitability, or is purchased at a premium by a larger company and then you sell for a higher price than you paid, then the difference is a ‘capital gain.’ This is called a ‘capital gain’ because you have literally had a gain in the size of your money or ‘capital.’

 

For example, if you purchase 100 shares of XYZ Company at $10 per share your total capital investment is 100 X $10 = $1,000. If in five years the share has gone up to $20 and you sell it, you will receive $2,000 (excluding fees), i.e. $20 X 100 shares = $2,000. Subtracting your initial capital investment of $1,000 from the $2,000 means you have realized a capital gain of $1,000. In other words you have made a 100% return over five years.

 

Correspondingly, you can make capital losses. If XYZ Company is poorly managed or overtaken by competitors, its value could drop. Say after five years it is only worth $5 per share and you decide to sell. You receive $5 X 100 shares = $500, which means you have lost 50% of your original $1,000.

 

In the case above, money you have in shares of XYZ Company is not generating any sort of cash dividend. You are instead relying on hope and the prospect of growth in the company, and thus capital growth or appreciation, to supply you with your return over time. This return is only realized when you sell the stock. Most companies listed on stock exchanges are small or mid-cap companies that don’t pay a dividend and are focused on growth. Sometimes the growth is spectacular and in the hundreds or even thousands of percentage points per year. This is especially the case in technology or mining sectors if a company creates a revolutionary product or strikes a huge mineral deposit. However, more often the reverse happens and a company has a catastrophic failure, loses much of its value or goes bankrupt, and shareholders lose their money.

 

Dividends

With larger mid- and large-cap companies, the growth rate is substantially reduced and so is the potential for capital appreciation of the company and shares though this can and still does happen, just at much more modest rates. However, the compensation for this lower growth rate is that these companies often pay cash dividends to shareholders. In addition, as dominant players in their industries, such companies tend to be very large and thus well insulated from bankruptcy, and they are often able to operate across international boundaries, thus reducing the political or economic risk of operating only in one country or region. This size and reach allows such companies to participate in booming markets such as in parts of East Asia, India and Latin America, thus offsetting the poor economic conditions in Europe and North America, even if these companies are based in London, New York or Toronto.

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