The expected total return is the complete return that investors receive throughout the lifetime of an investment, it’s composed of dividend payments and changes to a company’s stock price. Now if we were talking about something different like bonds, for example, it’s expected Total returns are gonna be different but for stocks expected total returns are composed of changes in stock price and dividend payments.
In this article, we’re going to talk about how to calculate the total return on a stock. The total return is a function of two things:
The dividends that are issued by the firm so they might give dividends per share, and then also
The capital gain is how much the share price increases during the period.
If we’re talking about a year, at the beginning of the year the share price is one amount and then at the end of the year, it’s a different amount. We’re going to look at that increase because that’s an increase in wealth or an increase in the return to the person holding the share.
We can parse these two elements out into a really nice formula where we say that the total return is equal to and we’ve got this D which is dividend and then P zero that’s the share price at the beginning of the year.
So this is the dividend yield that’s how we can think about this, then we also have the capital gain that’s our increase or our return on the share price. So what we’re doing with this is we’re going to make the difference between the start and end of the year’s price and then scale that and divide it by what we start with.
It’ll be a little bit easier when we put some actual numbers to it. We have the same denominator in each case, I’ve just kind of made it separate here so you understand the capital gain component and the dividend yield components of this but we can actually put it all together in one convenient formula and I’m just going to actually walk you through an example so it’ll be a little easier for you to understand.
Let’s say that you’re considering investing in XYZ corporation and you say “I want to know what the return was in the past year” and you look and say “well, their share price on January 31st was 31 dollars a share so that’s going to be P zero. Then we need to know the share price at the end of the year. At the end of the day on December 31st, we look at the share price and it was 32.50 dollars a share. Now we’re going to assume that the firm didn’t have any stock splits or anything during the year that would complicate things. So we went from and we think about we start at thirty-one dollars a share and then we went up to thirty-two dollars and fifty cents a share so we had an increase in the share price.
Then also during that year on June 30th, the firm issued a dividend of 25 cents a share so it’s going to be our dividend so now we can just plug numbers into our formula and find out what the total return for our stock is. Let’s say here we’ll have $1.75 in the numerator then you divide that by the 31, that’s going to equal 0.056 which is the same as saying 5.6%.
Now I’ve rounded here but basically, I just want you to understand that this means if you bought this stock on January 1st and you held it to December 31st of that year and these dividends are given your total return from owning the stock and it would be 5.6%.