The capital stock of a corporation constitutes the equity stake of the corporation’s owners. When you buy stocks in a company, you became one of the owners of that company.
In everyday language, the terms stocks and shares are commonly used interchangeably.
How can I make money from stocks?
The two basic ways of making money from stocks are:
- Buy a share and later sell it for a higher price.
- Own a share and receive dividend payments from the corporation.
What are dividend payments?
A corporation can elect to pay dividends to its owners (the shareholders). The dividend payment must be approved at a shareholder meeting. Dividends are usually paid in cash, but can be other assets as well.
Example: At the shareholder meeting, a dividend payment of $2 for each common share is approved. You own 400 common shares in the company. You will therefore receive $800 in dividend payment.
Essentially, paying dividends is a way for the company to distribute profits to its owners. It is usually well-established companies with steady earnings that elect to pay dividends. In newly formed companies, the money is more likely to be retained within the company, e.g. to be used for expansion or saved to allow the company to survive through rough patches in the future.
If you are looking for companies that have a steady track record of paying dividends each year, you are especially likely to find them in the following sectors:
- Oil & Gas
- Basic materials
- Real estate
- Bank & Financial
- Health care & Pharmaceuticals
Dividends and taxes
In many jurisdictions, dividend payments receives a favourable tax treatment compared to having an income from the profitable sale of shares. There are for instance jurisdictions where it doesn’t count as income from capital, or where it only partly counts as taxable income.
Investing in dividend-paying shares can be a powerful tax-planning tool, especially for persons who are close to being pushed into an even higher tax bracket.
Shares of preferred stock gets paid first when a company makes dividend payments. Shares of common stock only get paid if there is any money left for dividend payments when the preferred shares have been paid.
Discriminating within the same class of shares when dividends are paid is not permitted, but giving one class of shares preferential treatment over another class of shares is allowed.
The downside of preferred shares is that they typically come with no voting rights, which means the owner of preferred shares doesn’t have a say in how the company is run. This includes not being able to vote when the owners of common shares says yes or no to a suggested dividend payment.
I you sign up for a Dividend Re-Investment Program (DRIP), the dividends you receive wil be automatically used for purchasing more shares in the corporation.
- You can buy shares in public companies and non-public companies. The shares of public companies are traded at an exchange, e.g. the New York Stock Exchange or Nasdaq. The shares of non-public companies are traded over-the-counter (OTC), i.e. not on any exchange.
- Nowadays, shares are normally recorded electronically. That means you don’t receive a physical share certificate when you purchase shares.