Investment Glossary – Total Return
If you wound up here because you were trying to return cereal to a grocery store, you can click the “Back” button because you’re in the wrong place. If you wound up here because you want to understand what the total return of a stock actually shows you, then keep reading since we’re going to cover all of that. The total return of a stock is the change in price of that stock, plus any dividends that are paid to the investor over the course of holding it. So let’s do a quick example to lay out exactly what we’re talking about.
You buy Company X for $100 per share and hold it for one year. At the end of that year, the stock for Company X now trades at $110 per share. That $10 gain is called capital appreciation. And, because they have really good cash flow and value the ability to pay out profits to shareholders, they also gave you a $1 dividend every quarter, netting you $4 in your pocket or, as I like to call it, one trip to the dollar menu per quarter. So to reset all of this, you paid $100 for the stock, it is now worth $110, and you received $4 in dividends. That means that you earned $14 on your $100 investment over the course of the year, making your total return 14%. That’s what happens in the ideal situation.
Unfortunately, stocks don’t always go up. Sometimes, they go down. Let’s say that in addition to your investment in Company X, you also bought Company Y for $100 at the same time. They had a really tough year since there was a lot of competition and they had to deal with an environmental scandal. To make matters even worse, they changed their logo and everyone thought it was a bad move. Their stock went down to $85 over the course of the year. And while they paid a dividend, it was only $0.50 a quarter (half the rate of Company X’s dividend). So you invested $100, it is now worth $85, and you picked up $2 in dividends over the course of the year. So you ended up losing $13 over the course of the year, making your total return -13%.
That’s how total return works for individual stocks. But most investors end up owning more than one stock at a time. Maybe you own an exchange-traded fund or a mutual fund, or maybe you own multiple stocks. To figure out your total return for multiple holdings, you are simply going to examine these changes when combined. What does that look like? Here’s the math:
Capital Appreciation: $10 for Company X, -$15 for Company Y → -$5 total
Dividends: $4 for Company X, $2 for Company Y → $6 total
Total Return: $1, equaling 0.50% on the initial investment amount of $200
The above example is pretty simple since it uses two stocks bought at the same time and looks at the same holding period. In reality, you may be buying and selling stocks at different times. That’s why calculating a combined total return, especially for a large portfolio, can get pretty complicated. But this should give you the basic mechanics of calculating total return so you can start to understand what it means and see why it’s more than just getting rid of a cereal brand you don’t like.