Ticker&TapeHow shareholders make money
When you buy a share, you buy a slice of a real business. There are only a few ways that slice can make you money, and knowing them tells you what really drives a stock's price.
You own a piece of a business
A share is a claim on a company's future profits. The number that connects the business to your share is earnings per share (EPS): the company's net profit divided by the number of shares. If a company earns $500 million in a year and has 250 million shares, its EPS is $2.00.
Over time, stock prices tend to follow earnings. Suppose investors are willing to pay 25 times earnings for this company: 25 x $2 = $50 a share. If EPS grows to $4 and investors still pay 25 times, the stock is worth about $100. That is why growth traders care so much about earnings growth: rising profits are the fuel behind most big moves.
Price appreciation: the main source of gains
The most common way to make money from a stock is price appreciation: you buy at one price and sell later at a higher one. The difference is a capital gain. While you still hold the stock it is an unrealized gain (only on paper); once you sell, it becomes a realized gain.
Prices move on expectations, not just on today's profits. A stock can rise because investors expect earnings to grow fast next year, and it can fall even after good news if the news was less good than hoped. Price appreciation is never guaranteed: the same mechanism works in reverse, and a stock can lose much of its value.
Dividends and buybacks
A dividend is cash a company pays to shareholders out of its profits, usually every quarter in the U.S. The dividend yield is the yearly dividend divided by the price: a $50 stock paying $2 a year yields 4%. To receive a dividend you must own the stock before the ex-dividend date. On that date the price typically drops by about the amount of the dividend, so buying just before it to 'collect' the payment does not create free money.
A buyback is when a company uses its cash to buy its own shares in the market. With fewer shares, each remaining share owns a bigger slice of the profit. If our company keeps earning $500 million but reduces its shares from 250 million to 240 million, EPS rises from $2.00 to about $2.08 without the business growing at all.
Dividends are usually taxed, and investors outside the U.S. often have tax withheld at the source. Rules depend on your country, so keep records and check with an accountant.
Why growth companies usually don't pay dividends
A fast-growing company can usually earn more by reinvesting its profits (new products, new factories, more salespeople) than shareholders could earn with the cash. So most young growth companies pay no dividend at all, and their shareholders make money through price appreciation.
Mature companies with steady but slower growth, such as utilities or consumer staples, tend to pay larger dividends because they have fewer places to reinvest. For a growth trader, a dividend is a small bonus, never the reason to buy.
A worked example
You have a $10,000 account and buy 100 shares at $50, a $5,000 position. One year later the stock is at $60 and it paid $1 per share in dividends during the year.
Your total return is the price change plus the dividends: ($60 - $50) x 100 = $1,000, plus $100 in dividends, for $1,100. That is 22% on the position and 11% on the whole account. Now imagine the stock fell to $42 instead: you lose $800 on price, gain $100 in dividends, and end down $700, or 14% of the position. The dividend did not save the trade; the price did the damage. Record every trade, including dividends, in the Portfolio so you know your real return.
How a shareholder gets paid
| Price appreciation | Sell for more than you paid; the main source of gains for growth stocks |
|---|---|
| Dividends | Cash paid per share, usually quarterly; the price drops by about that amount on the ex-dividend date |
| Buybacks | Fewer shares outstanding, so each share owns more of the profit |
| Total return | Price change plus dividends received, minus costs |
Common mistakes
- Buying a stock only for its high dividend yield while the price keeps falling.
- Buying just before the ex-dividend date expecting free money, forgetting the price drops by about the dividend.
- Thinking a company that pays no dividend gives shareholders nothing.
- Measuring results only in dollars per share instead of as a percentage of the position and of the account.
Key points
- A share is a claim on profits; earnings per share links the business to the stock price.
- Most gains in growth stocks come from price appreciation driven by rising earnings.
- Dividends and buybacks return cash to shareholders, but mostly in mature companies.
- Total return is price change plus dividends, and it can be negative.
Check what you learned
Answer at least 2 of 3 correctly to complete the lesson.
1. A company earns the same profit this year as last year, but it bought back 10% of its shares. What happens to its earnings per share?
EPS is profit divided by shares. The same profit spread over fewer shares gives a higher EPS.
2. Why do most young growth companies pay no dividend?
Fast-growing companies usually get a better return reinvesting their cash, so shareholders are rewarded through price appreciation instead.
3. You buy 100 shares at $40, receive $50 in dividends and sell at $36. What is your total return before costs?
You lose $4 x 100 = $400 on price and gain $50 in dividends, so the total is a $350 loss.
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