Where Does the Money You Make on Stocks Actually Come From?

Distinguish a new share issue from a transfer of existing shares.

First, a company can issue new shares and raise money from investors. That cash goes into the company, into R&D, a new plant, whatever it needs to run the business.

Then, after the shares exist, holders can trade them among themselves. When you sell your stake to someone else, the money goes into your account. The company never sees it.

So when you buy an existing share on the open market, you're buying a slice of ownership in a company that is already paying its employees, suppliers, creditors and tax authorities. What comes back to you later is whatever the company chooses to distribute to owners, plus whatever a future buyer will pay for that slice.

That's why you can't ignore the operating business. Whatever is left over after all those payments is the base that dividends come from, and it determines how attractive the shares are to the next buyer.

Suppose a company reinvests retained funds in a new product. If it attracts customers and revenue covers the additional costs, more cash may become available to shareholders in the future. Investors may value that prospect even when current dividends are small.

Results also need to be measured per share. If total profits grow while the share count rises too, recalculate how much corresponds to each share. Read total profit, earnings per share and cash flow together.

For the full picture of how value gets created and then divided among the different claimants, see Value creation and income distribution.

Here's the part that trips people up. You can buy a stock in a company that improves every single year and still lose money. Because the moment you buy, you've already paid for a version of the future.

Consider an illustrative example, with all amounts in yuan. You buy a share at 100 when the company earns 5 per share a year. Price divided by earnings gives you a 20 times multiple. In plain terms: you paid 20 for every yuan of annual profit.

A year later the company does its job well. Earnings climb to 6 per share, a 20% gain. But the market has cooled on that name, and investors are now only willing to pay 15 times. The share is worth 90. Along the way you also collected a 2 dividend.

100 in, 92 back. That's −8%, even though the company grew its earnings by a fifth. Earnings rose 20%, but the price the market paid for each yuan of earnings fell 25%, from 20x down to 15x. The de-rating ate the growth, the dividend, and then some. (This example assumes no other transactions, share splits, dividend reinvestment, fees or taxes.)

Multiples bend with expectations: whether the growth will last, how much return investors want to demand, what other opportunities are on the table. So judging an investment really answers two questions at once. How good will this company get, and did I pay too much for that hope?

Buy at 100, hold a year, the stock is still worth 100, and you've been paid a 5 cash dividend. The total return before fees and taxes is 5%. Looking only at the share price would omit the cash dividend.

A cash dividend comes out of the company's own assets. Cash leaves the business to reach your account, so the share price typically reflects that change. Your total position is the stock's current value plus the cash in hand. Add them before judging your year.

And if profits are retained in the company instead, they're already working their way into the share price or into expectations of future cash. You shouldn't count them as a dividend you've already received, on top of that. Each piece, actual cash paid, share value, book profit, has its own place in the ledger.

This also explains what a sale really does. The seller receives cash today; the buyer steps into the right to the company's future distributions. Nothing inside the business changed just because ownership did. The company’s future operations and cash distributions affect the buyer’s subsequent holding-period return, linking the trading price to the business’s results.

Three checks cover most of the territory. First, what actually generates the revenue and cash, and is it repeatable or a one-off windfall? Second, how does that result translate into earnings per share once the true share count is counted? Third, what price did you pay, and how much of the future does that price already assume?

For the definitions, the financing walkthroughs and the accounting formulas, see Stock returns and purchase price. And if you own these stocks through a fund rather than directly, your own entry date matters just as much. That's the subject of Why a rising fund can leave your own account down.