Fundamentally, there are two ways in which you can make money from shares. One is to go for growth and then sell the shares at a profit and the other is to buy shares which will generate an income (e.g. pay dividends). As an investor, you have to decide whether you are primarily looking for growth or income and examine any prospective share purchase in the light of this decision. For the sake of completeness, while it is entirely possible for a share to deliver both growth and income, only one of these can be your main goal.
Going for growth
If you are going for growth then you have to recognize that you will only achieve monetary value for your shares when you sell them. In principle, a company could try to offer some value in the interim by paying a dividend, but in practice this carries risks. In simple terms, a company (like a private individual) can only spend money once. If a company spends money paying investors a dividend then it cannot subsequently use that money to finance growth. Depending on the nature of the company, this may not be an obstacle, however, it should be a consideration. On a similar note, growth investors need to remember that the value of their shares will depend on the market’s perception of them and that the payment, or otherwise, of a dividend, may influence this since dividends attract income investors. It may take a company longer to start paying dividends than a growth investor might expect or want. For example, although Microsoft floated on the stock market as a mature company (it was founded in 1975 and floated in 1986), it took over 15 years for them to start paying dividends (which they first did in 2003).
Investing for income
If you are investing for income, you are basically hoping that the company in which you invest will use your money to generate profits which will then be shared with investors, typically in the form of dividends. Successful income investing, therefore, involves looking at the share price of a company and determining whether or not it is justified based on the returns investors can expect to receive. There are various factors income investors can consider when making that judgment. These include:
One of the differences between exchange-listed companies and their private counterparts is that the former have to publish regular financial statements, whereas the latter does not. These statements will contain information about how a company earns its income and how it spends it; what the company holds in terms of assets and liabilities (and what is left over for shareholders) and how much cash the company holds, as well as other useful details such as significant shareholders. Potential investors can then use these hard facts to inform their decision-making.
While investors do have to remember that the fact that a company has performed well in the past does not necessarily mean it will perform well in the future, a company’s history can still provide useful insights which can inform an investment decision, for example, it might give an investor an idea as to whether or not a company has a history of adapting to change.
Another very pertinent question is the extent to which a company appears to be “future-proofing” its offering, whether that be goods or services as this will determine its viability as a long-term investment. Effective “future-proofing” relies on an understanding of patterns and trends, at least as they impact the particular industry niche so that companies can be prepared for the direction of travel which emerges.