There are two ways you can make money as a shareholder.
The first way is through capital growth. This occurs if the value of the shares you own increases between the time you buy and sell them.
Another way to gain comes as some companies use the profit they generate to pay dividends to shareholders as a reward for their investment.
When you combine the two, capital growth and dividends, you get total shareholder return.
Total shareholder return equals the profit or loss from net share price change, plus any dividends received over a given period.
Shareholder return is calculated pre-tax and assumes that all dividends are reinvested.
When you reinvest your dividends, it means you use all or part of the dollar value of your dividends to buy new shares of the company. This enables you to increase your shareholding in the company.
What does total shareholder return tell you?
Some stocks may see larger capital growth but pay lower or no dividends, while others may have a lesser increase in share prices but offer higher dividends.
By looking at a company’s total shareholder return, instead of merely its share price changes, you can work out how well an investment has performed over time.
On the Australian Securities Exchange, ‘price indices’ measure only the increase or decrease in prices. To calculate both the price changes and dividend income, you’ll have to look for the ‘total return indices’ or ‘accumulation indices’.
For example, the benchmark S&P/ASX 200 Index measures only the price changes, while the S&P/ASX 200 Total Return Index calculates both price growth and dividend income, assuming that all dividends are reinvested.
While it can be useful to compare the total shareholder returns of two different companies, keep in mind that past performance is not indicative of future performance. A company that performs well over one year may not repeat that the next year.
What else to consider?
Shareholder return is not the only thing you have to consider when choosing which shares to buy. It’s vital to use a number of valuation methods to assess the quality and value of a company.
That’s because share price growth, for example, can be driven by many different reasons including market sentiment and investor expectation. The share price does not necessarily represent the true value of a company and its earnings potential.
With this in mind, you should also consider looking at a company’s price to earnings ratio, which will tell you how its share price relates to its ability to generate earnings. The ratio allows you to compare a stock’s earnings potential against its peers in the same sector or to that of the broader market.
Other useful measures to look at include earnings per share and dividend yield.
It’s also important to examine a company’s position in its market, its management team, and its ability to grow in the future.
As an avid investor with a deep understanding of financial markets and a keen eye for evaluating investment strategies, I bring a wealth of knowledge to the discussion on shareholder returns and investment analysis. My experience spans years of active participation in the stock market, closely monitoring various financial instruments, and employing a diverse range of investment approaches.
Let's delve into the concepts outlined in the provided article:
1. Capital Growth: Capital growth is the increase in the value of an investment over time. In the context of shares, it refers to the appreciation in the market value of the stocks you own between the time of purchase and sale.
2. Dividends: Dividends are a portion of a company's profits distributed to its shareholders. It's a way for companies to reward investors for their financial support. Shareholders receive dividends regularly, and the amount is usually determined by the company's profitability.
3. Total Shareholder Return: Total shareholder return is a comprehensive measure that combines both capital growth and dividends. It calculates the profit or loss from net share price change and adds any dividends received over a specified period. The formula for total shareholder return is (Ending Value - Beginning Value + Dividends) / Beginning Value.
4. Reinvesting Dividends: Reinvesting dividends involves using the dividend income to purchase additional shares of the company, thereby increasing the overall shareholding. This strategy allows for compound growth by leveraging the power of compounding.
5. Performance Measurement: Evaluating a company's total shareholder return provides a holistic view of its performance over time. It considers both share price changes and dividend income. In the Australian Securities Exchange, the distinction between 'price indices' and 'total return indices' is crucial for a comprehensive assessment.
6. Caution on Past Performance: The article emphasizes the importance of not relying solely on past performance as an indicator of future success. Companies that performed well in one period may not replicate the same success in subsequent periods.
7. Valuation Methods: Shareholder return is just one aspect to consider when choosing stocks. Investors should employ various valuation methods to assess a company's quality and value. This includes examining a company's price to earnings ratio, earnings per share, and dividend yield.
8. Additional Considerations: Beyond financial metrics, investors should consider a company's position in the market, the competence of its management team, and its growth potential when making investment decisions.
In conclusion, a well-rounded approach to investing involves a thorough understanding of concepts like total shareholder return, careful consideration of valuation metrics, and a holistic evaluation of a company's fundamentals and market positioning. This knowledge equips investors to make informed decisions in the dynamic world of stock markets.
