Two Ways Stockholders Can Make Money from Owning Stocks?

What Are Two Ways Stockholders Can Make Money from Owning Stocks? Strategies Unveiled

May 31, 2024

The first and most evident way stockholders earn money is through capital appreciation. This occurs when the price of a stock rises above the initial purchase price. Consider the wisdom of King Solomon, who might have equated this to the increase in value of a well-tended vineyard. This principle remains true; a company that grows and increases its worth will see its stock price rise.

As the famous American financier and statesman Bernard Baruch once said, “Don’t try to buy at the bottom and sell at the top. It can’t be done except by liars.” Baruch understood that attempting to time the market is futile ideally. Instead, he advocated for a long-term approach, investing in solid companies and allowing capital appreciation to occur over time.

Investors like Warren Buffett have built empires on the back of capital appreciation, carefully selecting companies with growth potential and patiently waiting for the market to realize their value. For example, if an investor bought 100 shares of Apple stock in June 2016 at around $93 per share, their initial investment would have been $9,300. As of April 2023, Apple’s stock price is around $165 per share, meaning those 100 shares are now worth $16,500, representing a capital appreciation of over 77% in less than seven years. This demonstrates the power of capital appreciation in building wealth over time.

The second way stockholders can profit is through dividends. When a company earns profits, it can reinvest those earnings into the business or pay a portion to shareholders as dividends. The Medici family, the famous Italian banking dynasty and political power brokers during the Renaissance, understood the importance of generating multiple revenue streams. Just as the Medicis diversified their wealth through various business ventures and strategic marriages, modern investors can benefit from owning dividend-paying stocks to complement capital appreciation.

In summary, stockholders can grow their wealth through capital appreciation as stock prices rise and by receiving regular dividend payments. A balanced approach, as espoused by financial luminaries like Bernard Baruch and the Medici family, can help investors navigate the ever-changing market landscape.

Dividends: The Income of the Patient Investor

The second primary way to earn from stocks comes from dividends. When a company makes a profit, it can distribute some of it to its shareholders as dividends. This concept would resonate with Cicero of ancient Rome, who understood the value of sharing wealth for the republic’s stability. In the 20th century, investors like John D. Rockefeller saw dividends as a steady stream of income that could be reinvested to compound wealth.

For instance, consider Coca-Cola, a company known for its consistent dividend payouts. If an investor owned 1,000 shares of Coca-Cola stock, which currently pays an annual dividend of $1.76 per share, they would receive $1,760 in dividend income each year. If they reinvested these dividends into purchasing more Coca-Cola stock, their shares and subsequent dividend income would grow, demonstrating the power of compounding returns. Many investors, particularly those in retirement, rely on dividend income as a stable source of cash flow.

The Influence of Mass Psychology

Its participants’ collective emotions often sway the stock market. Benjamin Graham, an influential investor of the 20th century, would argue that understanding these emotional tides is crucial for investors. Investors can capitalise on market overreactions by going against the grain and purchasing stocks when others are fearful, leading to significant capital appreciation when sentiments change.

A prime example occurred during the COVID-19 market crash in March 2020. As fear gripped the markets and investors sold off stocks indiscriminately, the S&P 500 index fell by over 30%. However, investors who recognized this as an overreaction and bought stocks during this period saw substantial gains as the market recovered. By September 2020, just six months later, the S&P 500 had fully recovered its losses, and those who bought at the bottom saw their investments appreciate significantly.

Contrarian Investing: Going Against the Tide

Contrarian investing, a strategy that would have intrigued Niccolò Machiavelli, involves doing the opposite of the majority. The best investors of any era, like George Soros, have made fortunes by betting against the market consensus. By purchasing undervalued stocks that the market has shunned, contrarians position themselves for substantial gains when the market corrects its misjudgments.

A famous example of contrarian investing is Michael Burry’s bet against the housing market before the 2008 financial crisis, depicted in the movie “The Big Short.” While most investors believed the housing market was stable, Burry recognized the unsustainable nature of subprime mortgages and bet against them. When the housing bubble burst and the stock market crashed, Burry’s contrarian investment paid off handsomely.

Technical Analysis: The Art of Timing

Stockholders also benefit from technical analysis, a method of evaluating securities by analyzing statistics generated by market activity. A figure like Leonardo da Vinci, with his meticulous attention to detail, might have appreciated the patterns and trends that technical analysis seeks to decipher. Stockholders can maximise their earnings through strategic trades by identifying the right moment to buy or sell.

For example, a technical analyst might use a moving average crossover strategy, where they buy a stock when its 50-day moving average crosses above its 200-day moving average (a bullish signal), and sell when the 50-day moving average crosses below the 200-day moving average (a bearish signal). By following these signals, an investor could have avoided significant losses during the 2008 financial crisis by selling stocks as the moving averages crossed and then buying back in as the averages crossed again in 2009, capturing the subsequent market recovery.

Real-Life Success Stories

There are numerous stories of investors who made fortunes through these methods. Consider the Dotcom Bubble of the late 1990s and early 2000s. Those who recognized the overvaluation of tech stocks and sold off their holdings avoided significant losses. For instance, at its peak in March 2000, the NASDAQ Composite index, heavily weighted towards tech stocks, reached 5,048. By October 2002, it had crashed to 1,139, a decline of over 77%. Investors who saw the warning signs and exited positions before the crash preserved their capital.

Similarly, the investors who saw the potential in companies like Amazon and held on through the turbulence are now reaping the rewards of capital appreciation. If an investor had bought just one share of Amazon stock for $18 during its IPO in May 1997, that single share would be worth over $3,000 today, a staggering return of over 16,000%. This demonstrates the immense wealth-building potential of identifying promising companies and holding on for the long term.

Conclusion

Stockholders can generate wealth through capital appreciation and dividends, but successful investing requires a nuanced approach informed by historical wisdom and contemporary strategies. The stock market’s complexity demands both knowledge and resilience, as illustrated by data and expert insights:

According to a 2022 study by Hartford Funds, reinvested dividends accounted for 84% of the S&P 500’s total return from 1960 to 2021. This underscores the power of dividend reinvestment in long-term wealth creation. Warren Buffett, the legendary investor, emphasizes this: “If you don’t find a way to make money while you sleep, you will work until you die.”

Sir John Templeton, known for his contrarian approach, famously said, “The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.” This strategy has proven effective, with Templeton’s flagship fund achieving an average annual return of 15% over 38 years.

Peter Lynch, who achieved an average annual return of 29.2% while managing Fidelity’s Magellan Fund, advises: “The key to making money in stocks is not to get scared out of them.” This aligns with historical data showing that the S&P 500 has never delivered a negative return over 20 years, highlighting the benefits of patience.

Ray Dalio, founder of Bridgewater Associates, emphasizes diversification: “Don’t put all your eggs in one basket.” A Vanguard study found that a 60/40 stock/bond portfolio had a 10-year annualized return of 8.8% with lower volatility than an all-stock portfolio.

Robert Shiller, Nobel laureate in economics, highlights the importance of understanding market psychology: “The stock market is a voting machine in the short run and a weighing machine in the long run.” His research on market bubbles and behavioural finance has revolutionized our understanding of market dynamics.

Charlie Munger, Warren Buffett’s long-time partner, stresses the importance of multidisciplinary thinking: “You’ve got to have models in your head, and you’ve got to array your experience – both vicarious and direct – on this latticework of models.”

By integrating these diverse strategies and insights, investors can more effectively navigate the stock market’s complexities. However, it’s crucial to remember that investing always carries risk. As Benjamin Graham, the father of value investing, cautioned: “The investor’s chief problem—and even his worst enemy—is likely to be himself.”

Successful investing requires understanding not only market mechanics but also mastering one’s own psychology. By combining historical wisdom, contemporary strategies, and a deep understanding of market psychology, stockholders can position themselves to potentially earn substantial returns while managing risk effectively in the ever-changing stock market landscape.

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