Everyone talks about stocks and everyone thinks that people in the stocks business are always getting rich, that they are stealing from other people and that stocks are just something really mean. But what are stocks really? I will try to answer this question in this article.
Stocks are pieces of paper. But not just regular ones. Every piece of paper is actually a part of the company. For example a company that has one hotel has 1 million euros worth of capital, because this is how much one hotel costs. Now there aren’t many people in this world that would be able to afford to give one million euros to be the owner of this kind of a company. That is why we invented stocks. Let’s say we split this 1 mil company into 1.000 parts. That would mean that this company can have 1.000 owners, each one owning 1.000 euros worth of the hotel. This is more or less the explanation of the stocks. Stocks are these parts of the company.
Each stock would be worth 1.000 euros in our case and there could potentially be 1.000 owners of this company. Of course usually people own more than on share and there are way less stockholders than there are stocks. But you understand the idea now.
If this is all there is about stocks, how come some people are making lots of money out of it?
There are two ways to earn money from stocks. First one are dividends and second one are capital gains. You can read more about these two in other articles on MakeMoneyInStocks.net because here we’ll just give a very short description of both.
Dividends are nothing else but profits. If our hotel made 10.000 EUR of profit last year, this could be payed out to the owners. So if we split 10.000 EUR of profits between 1.000 stocks, then each stock would make 10 EUR. That’s not a lot since people are usually looking for 5-25 % return in stocks, but that’s not the only way to get money out of stocks.
Capitals gains are usually the ones that help people make these huge profits. What are capital gains? Well stocks aren’t always worth their nominal value. In our case, stocks have a nominal value of 1.000 euros, but they will usually be sold at a higher price. Why? Well because this hotel has a good brand, it makes profit and people are willing to pay for that profit. But stocks can also be worth less than a nominal value, if hotel has a “bad name” and investors don’t think it will make any profits. This speculations about profits are always changing and as they change, so does the price. Now if you can anticipate these changes you can make lots of money. Let’s give an example.
Today people think our hotel will not earn any money. That’s why the stock is worth only 500 EUR. But you believe that the company will make lots of profit next year and you buy 10 stocks. Next year, this actually happens. Hotel starts making profit and price of these stocks goes to 1.500 EUR. You now sell them at this price, because you think the hotel will stop making profit next year. You just sold 10 stocks with a total profit of 10.000 euros. This is how the capital gains work.
I hope you now understand better what are stocks and how you can make money out of them.