Investing in the stock market is one way to build long-term wealth, but it is important to understand your goals when you invest in individual stocks. Investors can buy individual stocks in hopes of future price appreciation, a solid dividend yield, or both.
Higher Stock Prices
When you invest in an individual stock, you do so in the hopes that the stock price will rise. When the price of a given stock goes up, that is considered to be stock price appreciation. For instance, if you buy a stock for $30 per share and it rises to $39 per share after a year, you have experienced a 30 percent stock price appreciation.
One of the things investors look for when evaluating a stock and determining its potential for growth is the year over year changes in earnings. A company that is growing at a higher rate often commands a higher price, and a higher price to earnings multiple, than a firm that is growing at a slower pace. For instance, a company that has been growing its earnings at 25 percent a year could have a price earnings multiple of 25, while a company with a 5 percent growth rate might have a much lower P/E multiple of 15.
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Having new products in the pipeline can also impact the price of company stock. Investors may place a higher value on a pharmaceutical firm with a promising cancer drug coming to market, or a computer firm with an innovative new storage and backup system. Watching the news and keeping an eye on the products the company is bringing to market can be a smart move if you are investing for growth and stock price appreciation.
Many investors buy stocks not for capital appreciation but for income. Many companies pay part of their earnings to shareholders in the form of dividends, and those dividend payments can provide a solid rate of return for investors. But companies with a history of raising their dividend payouts may experience stock price appreciation as well, as investors recognize the value of holding a stock that provides current cash flow as well as the potential for future growth.