Investing is one of the best ways to build wealth over your lifetime and it requires less effort than you might think. Making money from stocks doesn’t mean trading often, being glued to a trading screen, or spending your days just observing stock prices. The real money in investing is generally made not from buying and selling but rather from these three things: Owning a high-quality business, Receiving dividends from them annually, benefiting from stocks’ long-term increase in value.
How To Make Money in the Stock Market?
The best way to make money in the stock market isn’t with frequent buying and selling, but with a strategy known as “buying and holding.” This strategy was popularized by the father of value investing, Benjamin Graham, and is used by high-profile, successful investors like Warren Buffett and others.
As a retail investor, you need to focus on long-term returns and make a decision to invest for only long term. This means that you:
1. Select high-quality well-run companies with a strong fundamental and clean and clear history of shareholder-friendly management practices.
2. Hold each investment for a minimum of five years to reap the benefits.
If you have chosen strong, well-run companies, the value of your stock will increase over time. Before you can make money from the stock market, it’s important to understand how owning stocks works. This will allow you to make smart decisions about where to invest your money.
How does Stock Market work?
When you buy a share of stock, you are purchasing ownership in a company.
|Consider the following example: ABC Industry has sales of Rs10 Cr and a profit of Rs 50 Lakh. To raise money for expansion, the company’s founders approached an investment bank and they are ready to sell stock to the public in an Initial Public Offering (IPO). The company sells 100,0000 shares and sells them for Rs 25 each.
In this scenario:
1. Each share of stock in the ABC Industry is allocated Rs 5 of the company’s profit (Rs50 Lakh profit divided by 1000000 shares). This figure is known as the earnings per share (EPS).
2. If you acquired 100 shares for Rs 2500, you would be buying Rs 500 in annual profit plus whatever future growth (or losses) the company generated.
If the management team can increase sales by five times in the next few years, your share of profits could also be five times higher, making ABC Industry a valuable long-term investment Rs 500 in the company’s profit belongs to you but, however, you don’t immediately see the per-share profits that belong to you credited in your bank account.
Instead, management and the board of directors have options for what to do with those profits, and their choice mainly belongs to 4 categories:
1. The company can send you a cash dividend for some or the entirety of your profit. You could either use this cash to buy more shares or spend it any way you see fit.
2. The company can repurchase its shares on the open market and keep them in-house.
3. It can reinvest the funds generated from selling stock into future growth by building more factories and stores, hiring more employees, increasing advertising, or any number of additional capital expenditures that are expected to increase profits.
4. The company can strengthen its balance sheet by reducing debt or by building up liquid assets
Building Wealth by Investing in Stock
When you understand more about how stocks work, it’s easier to understand that your wealth is built primarily two from:
1. An increase in share price: Over the long-term, this is the result of the market valuing the increased profits due to business expansion or share repurchases.
For example, If a business with a Rs 10 stock price grew 20% for 10 years through a combination of expansion and share repurchases, the stock price should be nearly Rs 620 per share within a decade, assuming the same price-to-earnings ratio.
2. Dividends: When earnings are paid out to you in the form of dividends, you receive cash via a check, direct deposit into your brokerage account, checking account, or savings account, or in the form of additional shares reinvested on your behalf. You can also reinvest your dividends to purchase more stock in the company. This allows you to purchase more shares and steadily increase your stock holdings.
In the long run, however, your returns depend on the underlying profits generated by the operations of the businesses in which you invest. Choosing your stock wisely and holding onto it for the long term is the most reliable way to generate wealth.