As a stockholder, you own a piece of company, entitling you to potential profit on your investment. Making a return on your investment depends on how well the company does -- determined by its stock performance -- and if the company pays a dividend. Capital appreciation -- the stock price rising in value -- and dividends are the two ways you can earn a return as a common stockholder. Not all stocks rise, though, and not all companies pay dividends. Each type of return typically comes with a trade-off of pros and cons, which helps you decide which type of stocks to invest in.
Buy a stock, and when the price rises, sell the stock for a profit, or hold onto it and hope that it rises even further over the long run. The amount you make on the stock when you sell it is your "capital gain" for tax purposes. Calculate your percentage return on investment by taking the sale price, subtracting the purchase price. Divide that total by the purchase price, then multiply by 100. That is your percentage return on investment. If the stock drops, you can sell or hold onto the investment, but you face a capital loss and a negative return on your investment.
Pros and Cons
Over the long run a diversified basket of stocks is likely to appreciate, as the Standard & Poor's 500 -- an index which represents the U.S. stock market -- rose 9.9 percent, on average, per year from 1926 through 2010. The average return includes dividends; excluding dividends, the return from price appreciation alone is 5.7 percent over the same time frame. Many losing years occur as well, such as in 2008 when the Dow dropped 33.8 percent. Long-term capital gains (when the stock is held for more than one year) made from stock price appreciation are taxed at a favorable rate; typically you will only pay about the half the tax you would on ordinary income.
Some companies distribute a dividend -- a quarterly payment paid to stockholders for each stock they own -- providing a stream of income to investors. In order to receive the dividend, you must own shares of the company before the ex-dividend date. If purchase the stock on the ex-dividend date or later, you miss the cutoff, and won't receive that quarter's dividend. The record date is usually two days after the ex-dividend date and is when the company compiles a list of stockholders eligible to receive the dividend. These dates are available on Earnings.com. If you own 200 shares, and the company pays a $1 dividend, you'll receive $200 per year in dividend income, $50 per quarter, for the time you own the shares.
Pros and Cons
When a stock you own declines in value, dividends help offset some of the loss, or add to your total return if the stock price rises. A company can stop paying dividends at any time, leaving you without the income you have to come expect. For tax purposes, dividends are taxed as ordinary income, and, as of 2011, don't receive any preferential tax treatment.
- Thinkstock Images/Comstock/Getty Images
- Positive Effects of Stock Trading
- What Is the Difference Between Preferred Stock & Regular Stock?
- How to Calculate the Performance of a Stock That Has Dividends
- Should Dividends Be Ignored When Calculating Return on Assets?
- How Do Dividends Work With Short Positions?
- Are Stock Investments Tax Deferred?