How Does the Stock Market Make People Money?

A client recently asked me,

"How does the stock market actually work? How does it make me money?"

It's a great question because many people think of the stock market as numbers moving up and down on a screen. It can sometimes feel like a giant casino where investors are simply betting on whether prices will rise or fall.

But that's not what investing is.

When you buy a stock, you are purchasing a small ownership stake in a real business.

If you own shares of Costco, you own a tiny piece of Costco. If you own shares of Apple, you own a tiny piece of Apple. If you own an S&P 500 index fund, you own small pieces of hundreds of different businesses.

And businesses are in business to make money.

Costco earns money every time a customer shops in one of its warehouses. Apple earns money every time someone buys an iPhone. As these businesses grow their profits over time, investors generally become willing to pay more for ownership in those businesses.

That's how long-term investors make money on their initial investment.

Not because stock prices magically go up, but because the underlying businesses become more valuable and that value is reflected in the stock price.

The stock market doesn't create wealth. Businesses create wealth. The stock market simply allows us to participate in it.

Some companies also share profits directly with shareholders through dividends. Others reinvest profits back into the business to fuel future growth. Many do a combination of both.

Over time, investors can benefit from growing business value, dividends, or both.

A Simple Analogy

Imagine you own a rental property.

You don't buy it because you hope someone pays you more for it next week. You buy it because it produces income and you expect that income to grow over time.

If rents increase, the property becomes more valuable.

If the neighborhood improves, the property becomes more valuable.

If the income stream becomes larger and more reliable, the property becomes more valuable.

Stocks work much the same way.

Investors are trying to estimate how much profit a company will generate in the future and what those profits are worth today.

This is why two companies that appear similar can have very different stock prices. Investors are not paying for what a company earned last year. They are paying for what they believe it can earn in the years ahead.

But that naturally leads to another question:

If stock prices reflect business value, how do investors decide what a business is worth in the first place?

To arrive at an answer, investors generally focus on three things.

First, the strength of the business today. How profitable is the company? How much cash does it generate? How strong is its balance sheet?

Second, future earnings. Investors are not buying yesterday's profits; they are buying the profits they believe the company can generate in the years ahead.

Third, confidence. How certain are investors that those future earnings will occur? The more confidence investors have, the more they are often willing to pay for a stock.

As new information becomes available, investors continually adjust their expectations. That is why stock prices move every day.

Why SpaceX Is Such an Interesting Example

This framework helps explain the excitement surrounding the anticipated SpaceX IPO.

The company has built an extraordinary business through its space launches and Starlink satellite network. The question isn't whether SpaceX is impressive. The question is how much of its future growth should be reflected in the IPO price.

Supporters see decades of potential growth ahead.

Skeptics point to competition, regulation, execution risk, and uncertainty surrounding future technologies.

Both sides are ultimately debating the same three factors: earnings, growth, and risk.

Want to Go Deeper?

How do professional investors estimate what a business is worth?

One common approach is called a Discounted Cash Flow (DCF) Analysis, which attempts to estimate the value of a business based on the cash it may generate in the future.

learn more:

What Is a Discounted Cash Flow (DCF) Analysis?

 MWM’s Final Word

So how does the stock market actually make people money?

By allowing investors to participate in the growth and success of businesses.

Whether we're discussing a company like SpaceX, Costco, Apple, or a diversified index fund, successful investing is ultimately about owning businesses that create more value tomorrow than they do today.

As always, we will continue to focus on what I believe has worked best over time: owning exceptional businesses and giving them the time needed to grow earnings, increase their value, and reward you, the shareholder.

If you have questions about SpaceX or any other investment opportunity you're considering, please don't hesitate to reach out we would love to help!