When we buy a share we are buying a part of a business

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Over time if that business is profitable it will pay dividends as well as retain money to invest in the business to grow profit in the future years.

Let’s start a company named ABC with 1 share holder who tipped in $100. Therefore his share would be worth $100 and it would be backed by the cash in the company’s bank account.

Now ABC wants it start a business selling “widgets”. In the first year if they make a 10% profit they will make $10. They may pay half as a dividend ($5) to the shareholder and retain the other half ($5) to grow the business. This means the company ABC will now have assets of $105 making the shareholders 1 share worth$105.

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In the second year if they make a 10% profit they will make $10.50 (10% of $105). They may pay half as a dividend ($5.25) to the shareholder and retain the other half ($5.25) to grow the business. This means the company ABC will now have assets of $110.25 making the shareholders 1 share worth $110.25.

As you can see the process continues. This is how you can get increasing dividends as well as capital growth over tine by holding profitable companies.