I often see references to the "total return" of a stock. What does it mean and how is it calculated?
The total return of a security refers to the gain or loss, in percentage terms, derived from both the price change and any income the investment pays over a specific time period.
For example, for the year ended June 30, shares of Royal Bank of Canada rose 24.5 per cent. This is the gain an investor would have made from the price change alone.
But Royal Bank also paid dividends during the year. To approximate the total return, you could add the stock's yield, which was 4.1 per cent at the start of the period, to the price change, which gives you a combined return of 28.6 per cent.
However, this number underestimates the true total return, for two reasons. First, Royal Bank raised its dividend twice during the 12 months in question, so that needs to be reflected in the calculation. Second, by definition the total return assumes that all dividends, interest and other income are reinvested in the security at the prevailing market price on the payment date. As such, the total return includes the effects of compounding.
Taking these two factors into account, it turns out that Royal Bank's actual total return for the year ended June 30 was 29.2 per cent. As you can imagine, figuring out the total return with a pencil and a calculator would be an onerous process, particularly if you were looking at a stock's performance over many years when dozens of dividends were reinvested at different prices.
The good news is that there's an easier way: Get a website such as longrundata.com to do the work for you.
Let's say you wanted to know Royal Bank's total return, not just over the past year, but over the past decade. Using longrundata.com's dividend reinvestment calculator, you would enter the stock symbol (along with the international exchange code, which for Canada is the extension .tsx). You would then enter a start date of June 30, 2004, and end date of June 30, 2014, and hit "calculate return."
Result: Royal Bank posted an annualized total return of 14.15 per cent over that 10-year period. What does that mean in dollar terms, you ask? Well, according to the website, an initial investment of $1,000 would have grown to $3,757.64 over those 10 years. You can enter any starting value you like and longrundata.com will tell you what the investment would be worth at the end of the specified time period.
Here are the annualized 10-year total returns for a few other stocks I plugged into the website: Enbridge, 19 per cent; Canadian Utilities, 15.1 per cent; Procter & Gamble, 6.5 per cent; McDonald's, 17.9 per cent. I double-checked these figures against total returns provided by my Bloomberg terminal, and they were almost identical. Remember that total returns are backward-looking; a stock's future total return could be higher or lower.
Also keep in mind that, although the total return provides a thorough snapshot of an investment's performance, most investors won't actually achieve that return. One reason is taxes. If you hold a stock in a non-registered account, you'll likely pay tax on dividends – even if they are reinvested in additional shares – and you'll also pay capital gains tax when you ultimately sell the shares (assuming they rose in price). Another reason is that not everyone reinvests dividends in the same stock; some people like to spend dividends, or reinvest them in other securities.
Those caveats aside, total return is a useful measure for investors who want a complete picture of how their securities performed. It's also the standard that mutual fund and exchange-traded fund companies use when reporting performance figures. By focusing on the total return of your investments, you'll have a better idea of how you're doing than if you look at just the price change alone.