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Two Ways to Profit: Capital Gains and Dividends 

Dividends 

One way in which stock ownership pays a return is through dividends, the portion of a corporation's earnings that is paid to stockholders. To compute a stock's dividend yield, divide the amount of the annual dividend by the current price per share. 

For example, if a stock is priced at $10 a share and the annual dividend is $0.50 a share, the dividend yield is $0.50/$10.00, or 5%. 
Many common stocks and preferred stocks pay dividends. Most companies make their dividend payments on a quarterly basis. The amount and timing of dividend payments are at the discretion of the corporation's board of directors. There is no law that states a company must pay a dividend on its common shares, even if the company is profitable. The board of directors can raise, reduce or even eliminate a company's dividend rate; however companies try to maintain a fairly even flow of dividends, increasing the dividend when the company enjoys a growth in net earnings. 

The expected receipt of dividends is sometimes justification enough for investing in stocks, particularly if the yield on the investment exceeds the return afforded by saving accounts. Stocks that pay out a fairly generous dividend are known as income stocks. While dividends are important to many, most investors hope to gain an additional return in the form of capital gains. 

Capital Gains 

When buying stock, an investor is typically hoping that the perceived value of the company will rise, producing a capital gain when the shares are sold later to someone else at a higher price. Trying for such buy-low, sell-high profits over a short time span is a speculative activity known as  short term trading. Companies that are expected to grow over time are known as growth stocks. Investors buy such stocks in anticipation that their per-share value will increase over time as the company prospers and investors sometimes purchase securities only for their capital gains. Many income stocks pay out very little in dividends, sometimes not at all. 

Ultimately, stocks are bought for investment. Most well rounded portfolios have a balance between income stocks as in income situations, and growth stocks with capital gains potential. Some investors achieve this aim by buying a package of securities with such a mix, typically exemplified by growth income mutual funds.

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This page is created by Julia Lee '99 and is maintained by Professor Satyananda Gabriel of the Economics Department, Mount Holyoke College, January 1999.