3 Ways To Make Money Off Stocks

New investors often view buying stocks as the only way to make money in the stock market. Buy low, sell high is the old adage, but it’s not the only avenue to build wealth.

Others include ways to earn income from stock holdings through conventional and unconventional means as you’re about to see.

Buy Low, Sell High The Smart Way

When Warren Buffett learned how to invest intelligently from Ben Graham, he credits his mentor as showing him a quantitative approach.

Over time, disciples of the Oracle of Omaha learned that he called one variety of this approach cigar butt investing. It meant buying stocks at low prices relative to their intrinsic net worth and profiting from the difference when they reached their fair value.

Buffett credits his right hand man for half a century, Charlie Munger, with switching his focus from purely quantitative investing to a more qualitative approach. This strategy demanded looking less at price relative to fair value and more about the long-term growth prospects of a firm. 

Is it better to buy a company with a sustainable competitive advantage that will endure and grow over decades or one that will see a transient share price spike and then stagnate?

Buffett realized it was possible to integrate both Ben Graham’s and Charlie Munger’s approach into one cohesive strategy.  By so doing, he was able to scoop up shares of Apple in 2016 when the company was trading at a low price-to-earnings multiple and had great prospects to grow and expand its moat.

Dividend Investing

Another approach that Buffett employs is to pocket dividends from shares he owns. Purchasing stocks that pay a regular stipend is usually only possible when a company already has high cash flows that are stable and predictable. If it possesses those traits, it suggests that the firm may already enjoy a moat that protects those cash flows.

When you buy a dividend-paying stock, a key characteristic to note is the yield. The temptation for new investors is to buy stocks with high yields because they pay the most but the flaw in that thinking is high-yielding stocks often have fundamental flaws, such as fragile balance sheets laden with debt.

It’s generally better to scout for enterprises paying shareholders a reasonable dividend typically between 1% and 5% or perhaps even as high as 6%. Once you enter the 7% and above range it’s time to start investigating why the payout is so high, and whether something lurks under the surface ready to bite you.

Another way to tell if a dividend investment is a secure or risky bet is to examine the payout ratio. If the number is over 100%, the odds start to increase that the payout may be in jeopardy over the long-term. Typically, a figure below 50% suggests the risk to the dividend payment is low, though obviously there are no guarantees.

Lastly, a company that has a track record of paying dividends for many years can generally be trusted to continue doing so for the foreseeable future. Take a company like Coca Cola that has a 61 year streak of consecutively paying shareholders. That’s the kind of dividend stock you can count on to continue paying shareholders year after year.

Selling Call Options For Income

Beyond earning income from dividends, equity investors can also sell call options against their holdings to generate even more from their investments.

By selling a call option against a stock position, an investor engages in a covered call strategy. What makes it attractive versus a dividend strategy is that the investor proactively selects the time frame at which the calls are sold, whether daily, weekly, monthly or even yearly.

By contrast, a dividend income approach is subject to the discretion and timeline of the Board of Directors of a company and is typically quarterly.

An example of a covered call strategy would be when an investor who owns a stock trading at $27 per share sells a call option for $1 per share at a strike price of 30. One option contract is equivalent to 100 shares of stock so an investor with $2,700 worth of stock (100 shares) can sell $100 worth of call options, or 1 contract.

What makes the covered call strategy attractive is that by selling the call option, the risk in the trade is lowered from $27 per to $26 per share. Better yet, the strategy is repeatable so the investor can sell calls this month, next month and the month after if they wish. 

As long as the share price stays below $30 per share, the call options expire and the investor keeps the entire premium of $100 each time. But what if the share price rises above $30 per share?

If that happens the call option is assigned and the shares are sold at the agreed upon price, $30 in this case. 

Some investors don’t like covered calls because the upside is capped while the option is in place. For example, if the share price rose to $35 per share, the stock would still be sold at $30 per share based on the obligations of the call contract.

But that kind of thinking is short-term and misses the big picture opportunity to sell calls at regular intervals. Imagine selling calls for $1 each every month for 27 months, and each month the $27 cost basis and risk reduces by $1 per share. Quickly you can see the power of selling calls over the long-term is to reduce the effective cost basis all the way to zero.

Ways To Make Money Off Stocks

Three proven ways to make money off stocks are to buy firms with high growth prospects on sale, invest in dividend stocks, and sell call options against stock holdings.

Of the three, the first is arguably the hardest because it requires due diligence on the part of the investor to assess the quantitative and qualitative merits of a stock. Buying dividend stocks is a tried and tested method that has served conservative investors for decades.

Finally, selling calls is an income-producing technique that leverages options and can both lower risk and cost basis at the expense of capping upside. Over the long-term it can prove to be a highly lucrative strategy.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.