Work out an equity's price return and its total return
The idea
Price return measures only the change in price: (P1 - P0) / P0. Total return adds income received, usually dividends: (P1 - P0 + D) / P0, so it equals price return plus dividend yield on the starting price. Over several periods the returns are linked by compounding, multiplying (1 + r) for each period and subtracting one, not by adding them, and an annualised figure is the geometric mean of those period returns. Corporate actions must be adjusted for: after a split the investor holds more shares, so ending price and dividends are measured per original share. Price indexes report price return only, which is why a total return index of the same stocks grows faster over time.
A practice question
A share bought at 50 is worth 54 a year later, and paid a dividend of 1.50 during the year. The total return is:
- 11.0% — correct
- 8.0%Why not: That is the price return, 4 / 50. It leaves out the dividend received.
- 3.0%Why not: That is the dividend yield, 1.50 / 50, without the price gain.
Total return = (54 - 50 + 1.50) / 50 = 5.50 / 50 = 11.0%, which is the price return of 8.0% plus the dividend yield of 3.0%.
A harder one
A share bought at 25 was worth 28 after one year, having paid 0.50 in dividends, and 26 after two years, having paid 0.60 in the second year. The two-year total return, compounding the annual returns, is closest to:
- 9.0%Why not: Adding the annual returns of 14% and -5% instead of compounding them.
- 4.0%Why not: The two-year price return, 26 / 25 - 1, which leaves out both dividends.
- 8.3% — correct
Year 1: (28 - 25 + 0.50) / 25 = 14%. Year 2: (26 - 28 + 0.60) / 28 = -5%. Two-year total return = 1.14 x 0.95 - 1 = 8.3%.
The hardest tier
An investor buys one share at 90. The company later splits 2-for-1, then pays a dividend of 0.40 per post-split share. At year end the share price is 48. The investor's total return is closest to:
- -46.2%Why not: Comparing the post-split price and one dividend with the pre-split cost, ignoring that the investor now holds two shares.
- 7.1%Why not: Adjusting the price for the split but counting the dividend on only one share instead of two.
- 7.6% — correct
After the split the investor holds 2 shares. Ending value = 2 x 48 + 2 x 0.40 = 96.80. Total return = 96.80 / 90 - 1 = 7.6%.
In the app: 6 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
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