The stock markets are glorified by past tales of investors and investment fund managers building incredible wealth for themselves and their clients. An while many of these stories are certainly true, for every winner in the stock market there is at least one loser and often many more. That is because in order to “buy low” you have to find a seller who is ready to sell at the price you want — and he may have “bought high”. Also, in order to “sell high” you have to find a buyer who is ready to buy at the price you want — and he may never get his money back.
Stocks are certificates of ownership or valuation issued by companies to investments. In theory, if a company is liquidated all of its stockholders would receive an equal share of the company’s value after paying off all its debts. Liquidation means you sell everything: real estate, equipment, any receivables still owed to you, furniture, stocks in other companies, etc.
Although liquidation almost never happens for companies that are profitable and worth a lot of money, it is the potential value that you would realize from a liquidation that makes a stock valuable — even more valuable than it would actually be worth if the company did liquidate. The equity of the stockholders is an important part of the stock market; indeed, stockholder equity is the foundation of stock exchange markets.
Although many companies distribute some of their profits to shareholders through dividends, the dividends represent only a small amount of real profits. Many stockholders would prefer to keep the money invested in the company, unless it is extremely successful, to spur further growth and wealth building. But sooner or later people who buy stocks for long-term investments want to realize some return on their investment, and thus they ask for dividends.
But companies can also buy back some of their owners’ stock. In doing so they reward stockholders for remaining faithful to their investments. Stock buybacks may also increase the value of outstanding shares of stock because the potential liquidity of the company changes less than the amount of cash that was used to buy back the stock. Investors may also decide that the company has a bright future ahead of it and so buy stocks after large buybacks, thus driving the price of the stock up.
In addition to dividends and buybacks, investors may make money on the stock market if they have options to buy stocks at a discount. Many executives at large, publicly traded companies are compensated with generous packages of stock options and discounts. Hence, they may buy several thousands to millions of shares every year and then sell them on the open market, sometimes earning as much as a 50% premium (although 10-15% premiums are more common).
Other employees at publicly traded companies may participate in company-wide stock option plans, where they can purchase company stock at a discount through their payroll services. These employees don’t make much money individually but they do sometimes have an impact on a company’s stock price. One of the maxims of stock trading is that if you see insiders investing in their own company, that is a fairly reliable sign that things are going well — but this has not always proven to be true. Some executives for publicly traded companies have been caught in accounting scandals where they forged business activity and thus led their investors to believe their firms were doing well.
Finally, you can make money in the stock market by investing in mutual funds, where portfolio managers take responsibility for buying and selling stocks on your behalf and reinvesting any dividends into the funds. Your mutual funds may pay dividends directly to you, or you may buy and sell shares in them as if they were companies. In fact, a successful mutual fund will grow the value of its own shares over time.
Stock markets are volatile exchanges, and many people have lost fortunes trying to win at the stock market. It is always prudent to work with an experienced financial professional who places your interests ahead of their own. Financial counselors who earn commissions on client trades have often been accused of putting their clients’ interests last, but a good commission-earning financial manager knows that the more money he makes for you the more money he’ll make for himself.
You can always ask for a second opinion before making any investment. And if you feel you are being pressured to make a stock investment purchase then you should probably let the opportunity pass. As long as you have money to spend you’ll always have opportunity to invest in the stock market when you are not feeling pressured to make a decision.