InvestorQ : What is meant when we say returns on stocks? How are returns calculated?
Anamika Sodhani made post

What is meant when we say returns on stocks? How are returns calculated?

sarah Leo answered.
3 years ago

There are basically 3 ways to calculate returns on equities and each of them is popular among different sets of investors…

Firstly, there is the absolute return that you earn on the stock as the difference between the current market price and the purchase price. For example if you bought Tata Steel at a price of Rs.400 in 2014 and the stock price has gone up to Rs.660 in 2017, then your absolute return on Tata Steel since your purchase is 65% {(660-400)/440}. This is the simplest kind of returns and used by most lay investors.

Secondly, there is the approach of using dividend yield as a measure of returns. Dividend yield is the quotient of the rupee dividend paid out and the current market price. For example of PFC Ltd. has paid a Rupee dividend of Rs.12 for the full year and the current market price is Rs.164 then the dividend yield is 7.32% (12/164). It needs to be understood that dividends are tax-free hence effective returns will actually be 10.46% {7.32%/(1-0.30)}. This measure is useful for investors who are holding on to stocks purely for the dividend yield and are not worried about price appreciation.

Lastly, there is the most scientific method of calculation returns, which is the compounded annual growth rate of the stock. This assumes that returns are reinvested in the stock. Let us assume that you bought Havells at Rs.425. After 4 years if the stock price has appreciated to Rs.795, then it translates into a CAGR return of 17% annualized. To this you can add the dividend yield to get a better picture of returns.