Every investor wants to invest money and earn a profit from it. Let’s explore how to calculate stock returns, what methods are available for this, and what beginners might need to know.
From this article you will learn:
- The basics of stock returns, including how to calculate positive and negative returns.
- The impact of dividends and market price changes on overall profitability.
- Practical methods for calculating stock returns with step-by-step examples.
What is a Stock?
A stock is one of the most popular types of securities that anyone can purchase. Essentially, it grants the holder the right to receive a portion of a company’s profits.
The first stocks appeared in the 16th century at the world’s first stock exchange in the city of Bruges, where the concept of “stock quotations” also emerged.
Companies issue stocks to raise money for further business development. Stocks can be sold to specific large investors, or they can be listed on an exchange for public trading. Both individuals and legal entities can purchase stocks. A legal entity can become a co-owner of the company and participate in its management.
A stock can have a nominal value and an actual value. The nominal value refers to the cost of one share in the authorized capital, calculated as the size of the authorized capital divided by the total number of shares. The actual value is the current market price of the security.
If shareholders have confidence in the company, it will typically perform well. The stock price will rise, allowing investors to profit from dividends and the sale of the shares. Conversely, if confidence declines, the stock price will fall. Various factors, such as significant company events and market conditions, can also influence the stock’s value.
What rights does a stock grant?
- The owner of one share gets one vote at the shareholders’ meeting.
- The owner of ten shares gets ten votes.
- The owner of the majority of shares (50% plus one share or more, such as 51%) gains full control over the company.
Types of Stocks
There are two main types of stocks:
- Common stocks. These allow shareholders to vote at shareholders’ meetings, participate in company management, and receive dividends.
- Preferred stocks. These provide additional rights, such as a fixed dividend amount, but owners of these shares typically do not have voting rights (except in special cases like the company’s liquidation).
Preferred stocks usually make up no more than 25% of the total authorized capital.
Preferred stocks are further divided into two types: cumulative and convertible. Cumulative stocks are preferred shares that allow the accumulation of dividend income if dividends are not paid. For example, if a company does not pay dividends for two years due to a lack of profits and then resumes payments, the owner of these stocks can claim the dividends for the previous two periods. Convertible stocks are preferred shares that can be exchanged for common or cumulative shares under conditions specified in the company’s charter.
There is also another classification: outstanding and authorized stocks. Outstanding stocks are already in circulation and can be purchased on exchanges. Authorized stocks are those planned to be issued in a future offering.
What is Stock Yield?
The yield of a purchased stock determines how much money it will bring in or take away. If the stock earns more than was spent on it, the yield is called positive. If less was earned than was spent, it is referred to as a negative yield. Additionally, dividends must be considered when calculating yield.
How Can You Earn Money from Stocks? There are two ways to earn money from stocks:
- Through an increase in market value — market yield. A stock purchased today can be sold tomorrow or in a few years at a higher price. This is related to the increase in market value, which can also generate profit. Example: A stock was purchased for $100, and a few days later, its price reached $110, and it was sold. Therefore, the market yield will be: (110 – 100)/100 * 100% = 10 %.
- Through dividends — dividend yield. Some issuing companies distribute profits among all shareholders, and these payments are called dividends. If the company’s financial performance is good, the dividend amount may increase over time. Example: A stock was purchased for $190, and it generated $7 in dividends. The dividend yield of the stock is 7/190 * 100% = 3,68 %..
What Methods Are Used to Determine Stock Yield? There are several ways to calculate stock yield, depending on the available data. You can calculate the total yield, annual yield, market yield, and stock yield in annual percentages.
Dividend Yield of a Stock
We already touched on this formula earlier when discussing how to make money from stocks. The dividend yield of a stock is calculated as the ratio: r = d/p * 100%, where d is the annual dividend amount, and p is the stock price. For example, if a company’s stock is worth $200 and the annual dividend is $8, the dividend yield is 4% (8 divided by 200 and multiplied by 100%).
Market (Current) Yield of a Stock
To calculate market yield, the following formula is used: r = (P1 – P0 )/ P0 * 100% where P1 is the selling price of the stock, and P0 is the purchase price of the stock. Example: Suppose we bought a stock for $200 and sold it for $220. The current yield of the stock is 10 % (220 – 200/200* 100%)..
Total Yield of Stocks
This yield takes into account both dividends and the stock’s market value. The valuation of stock price and yield combines the previous two, and the formula is: r = (D + P1 – P0)/P0 * 100%. Example: Suppose the initial stock price was $1,000, and it was sold for $1,200, with dividends of $15 paid over the year of ownership. The total yield of the stock for the year would be: r = (15 + 1 200 – 1 000)/1 000 * 100% = 21,5 %.
Stock Yield in Annual Percentage
A stock can be held for a year or less. Therefore, a formula is provided that considers the holding period. If the holding period is less than a year, the resulting percentage needs to be multiplied by a factor (the number of days the stock is held divided by 360). Let’s examine this using an example:
- Take the figures from the previous example;
- Set the holding period to 200 days;
- Calculate the final result — r = (15 + 1 200 – 1 000)/1 000 * 200/360 * 100%= 21,1%
Where and How Can You Buy Stocks?
Stocks can primarily be purchased on stock exchanges. The largest stock exchanges in the US are the New York Stock Exchange (NYSE) and NASDAQ.
However, it should be noted that stocks cannot be purchased on the exchange directly. To buy stocks, you need to use the services of a broker. A broker is a special company that provides investors with access to the securities market and keeps records of their assets.
A broker’s responsibilities include:
- Executing transactions on the exchange;
- Registering securities in the client’s name;
- Preparing transaction reports;
- Providing margin trading funds (if necessary).
For all the services mentioned above, the company charges its commission. Different brokerage companies offer varying commissions, service conditions, and more. When choosing an exchange, pay attention to the stock exchanges the broker works with, the markets offered, and other important conditions. Of course, also consider the size of the commissions. To calculate your yield, use the formulas and examples provided above, which you can easily understand.