Most people know that the stock market can be a very lucrative investment. Indeed, most investment strategies have some sort of stock component to them. Over centuries of investments, stocks have demonstrated their ability to generate significant wealth and returns for their investors.
However, the reasons behind why someone buys a stock are not always clear. Sure, “making money” is usually chief among the reasons for stock purchases, but not always. More to the point, there are a variety of ways that someone can make money off of a stock purchase, and there are different strategies behind selecting stocks that fit someone’s financial goals.
As such, here’s a closer look at just why someone buys a stock.
Capital Appreciation
The main reason that someone makes a stock purchase is to earn money from share price appreciation.
At its core, this means that someone buys a stock with the hope that the stock will go up in value over time. At a later date, that stock will be sold, allowing the original investor to reap a healthy profit.
People who buy stocks for capital appreciation are generally looking for a few types of stocks:
- Value stocks: Value stocks are stocks that are believed by some to be trading at prices below their intrinsic value. This means that the price may be suppressed for a variety of reasons, providing investors with a potential “bargain.” Value stocks are believed by investors to be likely to increase over the long-term. As such, investors can buy these stocks and turn a profit at a later date.
- Growth stocks: These are companies that may not be generating a profit yet, but appear likely to do so in the future. Generally, they are growing top line sales at a rapid pace. As such, investing in them represents an opportunity to grow one’s portfolio and make a significant return on investment. These are often technology or medical stocks that have a hot new product that could take their industries by storm.
- Blue-chip stocks: Blue-chip stocks refer to market leaders. These are older, more mature companies, and thus represent more conservative investments. They are not likely to show explosive growth, but should produce gains over time. They are also likely to offer dividends.
Different financial strategies can impact the stocks that are purchased in a different way. For example, someone who is younger – and can thus afford losses – may try to invest in growth companies. These stocks may be riskier, but a younger person has likely more time to gain back whatever losses they may incur.
Conversely, someone who is older may not have as much time to potentially lose a good chunk of their nest egg. As such, they may make more conservative investments, such as in blue-chip stocks. An older person is also more likely to invest in stocks for income, and that goal may be more easily achieved by investing in certain dividend stocks.
Dividend Payments
Some stocks offer dividend payments. These are regular payments – usually paid on a quarterly basis – that return a portion of the profits to shareholders.
The dividend offered is calculated by dividing the payment made to shareholders by the share price. For example, if the share price is $20 and the dividend payment is $1, the dividend yield is 5%.
The dividend is usually set at a certain amount, and management aims to hold the dividend steady or increase it over time.
Dividends can provide a steady stream of income to investors. To be clear, there is no legal requirement that a stock offers a dividend. Dividends can be cut or eliminated at any time. However, many investors invest in dividend-offering stocks to provide stable income.
Dividend paying stocks are typically popular among more mature or income-oriented investors. As such, cutting or eliminating a dividend is viewed as a sign that a company is having financial troubles. Management is thus very reluctant to reduce or eliminate a dividend.
Voting Rights
Stock ownership can be about more than just financial gain. In some cases, a person or company may purchase stock as part of an effort to gain more control over a company.
By law, stockholders are entitled to certain voting rights. The more shares someone owns, the greater voting power they have. These votes can influence the future of the company and its strategic direction.
Some stakeholders may acquire shares in order to perform a hostile takeover. Often, companies will purchase large amounts of shares, and then use their voting rights to execute a corporate takeover of that organization.
Votes do not have to be made in person and can be made via proxies that are usually sent to the shareholders before any vote occurs.
ESG Vs Sin Stocks Philosophy
Sometimes, company decisions can be made on the basis of what is good or bad for society at large, and for the planet. There are two types of stock that epitomize this: ESG and Sin Stocks.
ESG stands for Environmental, Social, and Governance. ESG stocks are stocks that adhere to certain principles of morality when it comes to the company’s impact on the environment and society at large. They also have solid and “moral” leadership.
In contrast, sin stocks encompass companies that are engaged in producing a product or service that is typically viewed as morally questionable, such as selling cigarettes and alcohol, or facilitating gambling.
Some people will only invest in a stock if it meets certain ESG criteria. Sustainable investments adhere to these principles. Many investors will intentionally avoid stocks that fail to meet ESG metrics. This can unquestionably have an impact on one’s return, and these factors should be considered before making any final investment.
Selling Calls For Income
A final category of shareholder is the call options seller. These are stockholders who own shares of companies not just for capital appreciation and dividends, but also to earn income from selling call options against the shares.
Some companies offer enormous call premiums that are attractive to shareholders. It’s possible at times to receive as much as 10% of the value of a stock in call premium before an earnings announcement when implied volatility of options is high.
By repeating this strategy time and again, covered call sellers can generate sizeable returns and produce income streams. It’s not a strategy that applies just to volatile share prices either, the same strategy can be applied to highly stable, mature companies, albeit with lower percentage returns.
#1 Stock For The Next 7 Days
When Financhill publishes its #1 stock, listen up. After all, the #1 stock is the cream of the crop, even when markets crash.
Financhill just revealed its top stock for investors right now... so there's no better time to claim your slice of the pie.
See The #1 Stock Now >>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.