Stock Market Investing 101 – How Can Stocks Make You Money?

June 27, 2008

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Investing in the stock market can be overwhelming for a beginner but the potential financial rewards are enough to motivate many people to learn how to invest in stocks.  One mistake that many beginners make is to get caught up right away in buying and selling stocks without really understanding what a share of stock represents, how the stock market works, and why buying and selling stock can lose them or make them money.

The best place to start is with a few terms that are often used when discussing the stock of a company:

  • share of stock
  • share price
  • shareholder

When investors buy stock in a company, they share the potential profit and loss of the company in proportion to the amount of stock they buy.  This concept of sharing is key to learning about investing in the stock market. 

What is a Stock?
A stock represents a piece of ownership in a company. You may ask, why would a company willingly sell the right to “outsiders” to become a partial owner of the company?  It’s a good question, many business owners work very hard to build their companies and don’t like the idea of someone else telling them how to run it.  However, all businesses need money to operate and grow and one way for a company to raise money is to sell some rights of ownership of the company.

Now the business owner doesn’t want to sell the rights to the entire business, just enough to get the money they need.  So they divide the rights of company ownership into units, each of which is a share of stock, and they make those shares available for investors to purchase.

What is an Investor?
An investor is a person who sees potential in the business and is willing to give the company money up front in return for a partial share of ownership, a share of stock, that entitles them to share in the future profit and loss of the company.  The reason for my heavy emphasis on sharing is that as an investor, or shareholder, the fate of the money you pay for your shares of stock is tied to the success or failure of the company.  Since you share in their profits and losses, you should only buy stock in a company that you think has a good chance of success.

How Do Investors Make Money?
As a shareholder, the reason you invested money into the company is that you expect the business to take that money and use it to create profits.  If the company is profitable, the value of your shares of stock should increase.  How much the shares increase and whether they increase at all is determined by the stock market, the details of which we’ll cover in later articles. 

Assuming that the value of the shares of stock goes up when the company is profitable, you can sell your shares on the stock market for a higher price than you paid for them.  The difference between the original price you paid for the stock and the selling price, minus any transactional fees & taxes, is the amount that you profit.

Another possible scenario where an investor can make money is if the company has a profitable period and decides to give a portion of those profits back to investors.  The money given back is called a dividend, each shareholder would receive a certain amount of money for each share of stock they own.

Understanding the Stock Market
Now that you understand that companies sell stock in order to raise capital and that investors take the risk of buying the stock so that they can share in the potential profits of the company, the next thing to look at is how stocks are priced, bought, and sold.  In the next Stock Market Investing 101 article we’ll take a look at how the stock market works.

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Ben Edwards, the founder of Money Smart Life, saved up enough to buy a Nintendo back when he was 12 years old. When he used the money to buy shares of Wal-Mart stock instead, he knew he wasn't like the other kids... His addiction to personal finance has paid off for his family and now he's helping you to afford the life that you want. Check him out on the web at Google Plus, Twitter and Facebook.

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