The idea is that a shareholder’s interest in a growing publicly traded company will become more valuable over time.
The simplest answer is: to make money!
Owning shares of a company’s stock is known as taking a long position, and this is done in the belief that the company is going to increase its earnings and profit margin into the future, or will at least remain steady.
There are three ways to make money on stocks:
The market price for a share of a company’s stock can go up or down according to the company’s performance and market sentiment surrounding the company. When the price of the shares you own increases, your holdings have experienced capital appreciation.
If you sell them at that point, you would have followed the old adage “Buy low, sell high.”
For example, if you bought 100 shares of corporation ABC at $10/share, and the next day/month/year, the shares were valued at $11/share, selling the shares would generate a profit of $1/share times the number of shares you own, or $100. The $100 is called your Realized Gain on Capital Appreciation of the stock.
If you had kept the stock, the $100 would be referred to as your Unrealized Gain on Capital Appreciation of the stock. Conversely, if the stock were valued at $9/share instead of $11, $100 would be your Unrealized Loss, and if you sold the stock at $9/share, you would have $100 of Realized Capital Loss.
If a corporation decides they have extra cash they may not want to reinvest into the company, the corporation can decide to pay out “dividends" to its shareholders.
For example, if you own 100 shares of ABC, and ABC decides to pay out $1 per share to its shareholders, you would receive $100 in dividends. Dividends can be taken as income or reinvested.
When reinvested, they add to the compounding effects of appreciation over time. When looking at the historical performance of the market using the S&P 500, the average rate of return is significantly higher when historical dividends are reinvested instead of just taken as income.
Just a few percentage points over a 20-30 year timespan can make a monumental difference in the ending value of a portfolio and the quality of the investor’s lifestyle in retirement.
Suppose company ABC is trading at $10/share, and its competitor, the larger company DEF, purchases ABC and buys the stock for $20/share. Then, the shareholders would enjoy a Capital Appreciation of $10, or 100%.
The shareholder could either receive cash or shares of the bigger company equal to the amount of the appreciation, which is called a stock swap.
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