Lesson 2 of 43: How Do You Actually Make Money with Stocks?

 

When it comes to investing in stocks, there are two simple ways you can make money:

  • Collect dividends
  • Sell a stock whose price has gone up from where you bought it

There’s a ton of research, analysis, debate, trial, error, and innovation around how to buy the best stocks. But at the end of the day, there are pretty much only two ways to make money from stock investing.

(NOTE: This is one of 40+ lessons in our FREE course: How to Invest in Stocks: Learn How to Buy Stocks, Make Money, and Avoid Mistakes. We'll bring you from beginner to confident investor fast, helping you make money and avoid mistakes along the way.)

Make Money from Stocks by Collecting Dividends

A dividend is a cash payment from a company to its shareholders.

Many companies (literally thousands) pay dividends to their shareholders on a regular basis. 

Dividends are usually paid out quarterly and over a full year they typically add up to somewhere between 1% - 6% of the amount you would pay to buy a single share of stock.

This ratio of the amount of the dividend paid in a year compared to the current price of the share is called the “dividend yield.”

Here’s the official dividend yield formula:

Think of dividends like this: You’re handing over some amount of money to buy a tiny portion of a company, and in return the company will pay you a tiny portion of their profits (since you’re now an owner).

When you look at dividend yield, you’re basically asking, “How much dividend money will you pay me in a year compared to how much it costs me to buy a single share of your stock?”

Let’s look at an example.

Let’s say you’re considering buying Visa (V) stock. Their current dividend yield is 0.7% (yes, less than 1% - not very good).

What that means is that if you shell out $136.79 to buy a single share of Visa, they will pay you $1.00 in dividends over the next year. Not a great deal.

Now, Visa may be a good investment for other reasons, but from a dividend perspective you can do much better.

How much better?

Well, how about AT&T (T) stock? It will cost you $32.73 to buy a single share of AT&T, and in return the company will pay you $2.00 in dividends over the next year. That’s a 6.1% dividend yield (superb!).

Now, $2.00 may not sound like much, but keep in mind that’s what shareholders receive for each and every share they own. So if you invested $10,000 in AT&T stock, you would receive roughly $610 each year in dividend payments ($10,000 in AT&T shares x 6.1% dividend yield). Not bad!

Keep in mind, it doesn’t matter that AT&T is paying $2.00 in dividends while Visa is only paying $1.00. That’s not what makes AT&T a higher dividend yield stock.

It’s the ratio of AT&T’s $2.00 dividend compared to its $32.73 stock price which is much better than the ratio of Visa’s $1.00 dividend compared to its $136.79 stock price.

  • AT&T: $2.00 dividend / $32.73 stock price = 6.1% dividend yield
  • Visa: $1.00 dividend / $136.79 stock price = 0.7% dividend yield

Or, another way to look at it is this: If you invested exactly $10,000 in each stock, AT&T would pay you far more in dividends each year. That’s why it’s a better dividend-paying stock than Visa.

There’s a lot more to learn about dividends (which we’ll cover in Lesson 9 of 43: Dividend Stocks: How Yield & Income Can Boost Your Investing Profits), but for now just keep in mind these seven basic dividend concepts:

  1. Dividends are regular cash payments from a company to its shareholders
  2. Dividends are usually paid out quarterly (but not always, they can range from a single one-time payment up to regular monthly payments)
  3. Dividend payments usually remain fairly steady or trend slowly upwards over time (but they can also sometimes decline if a company is struggling financially)
  4. Often slower-growth companies pay dividends and faster-growth companies do not (there are exceptions)
  5. Dividends (or high dividends) don’t automatically make a stock a “good” investment or better than other stocks
  6. Dividend yield is a powerful metric to measure how much you’d make in dividends each year compared to how much you’d have to invest
  7. Most dividend yields range from 1% up to 6%, but there are some companies that can go much higher

Dividends can be an extremely powerful way to make money in the stock market. But they’re not the only way (or even the main way) that investors try to make money.

The main way to make money with stocks is through what’s called “price appreciation.”

Make Money from Stocks When Prices Go Up

This is the simplest way to make money with stocks, and the way that most people think of when it comes to stock market investing.

Put simply, you buy a stock because you think its price will go up.

Maybe you think the company is going to grow because its products are great, or it has a brilliant CEO, or it’s expanding into new international markets.

Or, maybe you think the shares are “undervalued,” meaning they’re currently trading below what the company is really worth. So you figure if you buy now, the stock will eventually move up towards what it’s worth (making you money in the process).

Let’s look at a simple example.

Let’s say you think shares of Verizon Communication (VZ) are currently undervalued and the company is going to do incredibly well when it rolls out 5G cellular coverage across the U.S.

So, you buy 200 shares of Verizon at a price of $50 per share (their current price is actually $56.88, but let’s just call it $50 to keep the example simple). In total, you’ve invested $10,000 into Verizon (200 shares x $50 per share).

Now, let’s say you’re right, 5G is a success and the stock goes up! Pretend that over the next five years, the stock rises from your cost of $50 per share up to $75 per share.

You’ve turned your initial investment of $10,000 into $15,000 (200 shares x $75 per share). That’s a return of 50% in just five years, earning you $5,000 in profit - well done!

And that doesn’t even include Verizon’s healthy 4.4% dividend yield which you would've collected each year along the way.

To be clear, I’m not suggesting Verizon’s stock is going to appreciate like that, but you get the point of the example.

When shares go up, you hold what’s called an “unrealized gain,” which means you have a gain but since you haven’t yet sold your shares and locked it in, it’s still considered “unrealized.”

Once you sell and officially lock in your trade, it becomes a “realized gain.”

How Much Money Can You Make from Dividends and Price Gains?

We have an entire lesson on what makes stock prices go up, so we’ll keep it brief here.

Most people expect prices to go up either because the company is going to grow or because it’s currently undervalued (or both).

There are certainly other scenarios that can drive price increases, such as when a company announces it’s being acquired. Acquisitions can often drive a very big and very fast spike in a company’s stock price.

But, for now just keep in mind that your two main ways to make money from stocks are:

  • Collect dividends
  • Sell a stock whose price has gone up from where you bought it

Combining these two strategies (buying a stock with high dividends whose price will appreciate) can create incredibly powerful results, which we’ll cover in a future lesson.

But first, let’s talk about one of the BIGGEST questions in stock market investing: "Lesson 3: How Much Money Can You Make Investing in Stocks?"

This lesson is from our free course, “How to Invest in Stocks: Learn How to Buy Stocks, Make Money, and Avoid Mistakes.”

We cover many powerful strategies for making money in the stock market while avoiding common mistakes.

The course has over 40 lessons with handouts, guides, and strategies based on decades of stock investing research and experience.

We can bring you from beginner to confident investor FAST, helping you make money and avoid mistakes along the way.

In the next few lessons you will learn...

  • How saving just $10,000 per year can grow to $1,809,434
  • Why you can't afford to ignore dividends
  • How the market has never lost money over a 15-year period
  • How IPOs work and whether you should buy into them
  • The differences between small-cap stocks and large-cap stocks

Data as of 10/23/18

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