Profit is a way to share your fortune with the owners of the company. The basic idea is to distribute all or some of the profits because the company has no reason to store them. First, there are two types of stocks: preferred and common.
The former often comes with concessions (such as guaranteed profits, increased voting power) but most people deal with what is called common stock. Things like you and me trade in small fry stock markets. For simplicity, we will only talk about common stock here.
Profit is paid based on the number of shares you have. Person A, with 1,000 shares, acquires more than half of Person B, which has 2,000 shares. You will usually see it mentioned as X cents per share. These cents per share can be paid quarterly, annually, or semi-annually. There can also be special profits, where the company simply decides whether to take the windfall out of what the division has sold, or what is the most lucrative deal.
But since shares change hands so fast, when it comes time to send a check, how is the “ownership” decided? There are a couple of dates of interest to determine. First, the announcement by the board. Basically, company leaders announce when profits are coming, and when. It serves as a head-up for existing and potential investors.
Then comes the record date. This is the day you should own the shares. But it’s not that simple. SEC rules state that in order to be eligible for a profit, your trade must be settled at least 3 days before the record date. The goal is to level the playing field and ensure that any breaks from different brokerages are corrected. Therefore, the owner stays out for 3 days at the time of closure.
Technically, the owner can sell it the next day – before the formal closing date – and still make a profit, while the new owner will not receive anything until the next time. This is why you often find that prices pay a small dividend, as assets move out of the company, thus reducing its value to new buyers. Existing owners are, of course, compensated for the price reduction through hard, cold cash.
Finally, there is the distribution date – which only happens when checks are mailed and money is deposited in bank accounts. This could be several weeks after the record date. Stocks held in mutual funds are slightly different but basically work the same way.
Many people have chosen to release year-end profits as a “mop-up” effort, but the basic idea of distributing money to shareholders is correct. Some companies issue stocks instead of cash. This stock profit increases the number of your shares, so instead of having 500 shares of Company X, you now have 520 shares, which can be sold and traded like any other stock position.
Many others, especially growing companies, choose to abandon profits altogether. These are usually young, growing companies where money is better spent on growth and expansion. Adult companies are less cunning and try to play their comfortable role as cash cows and are happy to share their profits with investors.
The former is riskier – with a higher probability of making a large payment – while the latter is often a safer option. Nor is the approach wrong, and profits alone do not indicate whether a company is going to beat it, but it is certainly a piece of the puzzle.