Performance is one of the main indicators of stock investments, by which you can assess their profitability, viability and compare them with each other. Often, to assess the profitability of investing money, the risk-return ratio is used. The reason is simple: indicators such as profitability and risk in themselves are not very informative.
What is the point of investing in instruments with a high level of risk and a low potential return? If the risk of loss is high, the potential reward should be high. The yield value indicates how much money an action contributes or removes. If you made more money on a stock than you spent on it, the return is considered positive. If you spent more than you earned, the return is called negative. In addition, dividends received must be taken into account when assessing profitability.
By buying stocks, an investor plans to earn a profit due to the increase in market value (market return). A stock bought today can be worth several times as much in a few years. Or it may cost a little more in a few days. In either case, an increase in the share price (market value) allows the investor to earn money by reselling assets.
How is performance calculated?
The performance is calculated using the formula:
(sale price – purchase price) / purchase price * 100%
For example, if a stock was bought for $200 and sold for $210, the market return is as follows:
(210 – 200) / 200 * 100% = 5%
Thanks to dividends (dividend yield) Some issuing companies regularly distribute a part of the income to shareholders. These payments are called dividends. Each issuer determines the amount and terms of payments at its discretion. If the company’s financial affairs are going from strength to strength, the amount of dividends may increase over time.
The dividend yield is calculated using the formula:
dividend / share price * 100%
For example, if a stock was purchased for $200, and the dividend for that stock was $8, the dividend yield for a stock is as follows:
8/200 * 100% = 4%
Calculation of total return
To get a more objective picture, both performance measures are taken into account: market and dividend.
The total return is calculated using the formula:
(dividend + (sale price – purchase price)) / purchase price * 100%
For example, we take the figures above: a share was bought for 200 USD, sold for 210 USD and the dividend of the same was 8 USD.
(8 + (210 – 200)) / 200 * 100% = 9%
Calculation of annual profitability
To find the annual percentage return on the stock, you need to calculate how many days the investor has owned the stock from the time of purchase to the time of sale.
We calculate it using the formula:
(sale price – purchase price) / purchase price * number of days in a year / number of days owned * 100%
Suppose a stock was bought for $200, and after 90 days it was sold for $210. The calculated annual return value is:
(210 – 200) / 200 * 365/90 * 100% = 20.27%
Let’s say you bought a stock for $100 with a factor of 1.7. During the first year, the dividends amounted to 15 USD. The second year, the return is 20%. In the third year, dividends reached 45%. The performance was paid evenly by quarters. In the third year, the investor sold the asset 90 days before the dividend payment. The ratio of the sale price to the purchase price is 1.25.
When so many actions have been taken, calculating the final return can be challenging. This is where the formula comes in handy. The task is to calculate the final return of the shares.
First, the cost of buying and selling is calculated:
Purchase price = $100. × 1.7 = $170.
Sale price = $170. × 1.25 = $212.5.
Next, the current profitability is determined:
Dividends in the first year are $15, the current yield in the second year is 20%. $170 × 0.2 = $34
Considering the 45% rate for the third year, receiving dividends for only 3 quarters, the third year yield equals $100 × 0.45 × 0.75 = $37.5.
Calculation of the average annual coupon dividend: (15 + 34 + 37.5): 2.75 = $31.45.
In addition to the dividends, the shareholder obtained a benefit for the difference between the purchase price and the sale price of the security:
212.5 – 170 = $42.5.
If all the values of the formula are substituted, the final profitability is obtained:
(31.45 + 42.5 / 2.75) / 170 × 100% = 26.79%.
It turns out that for every dollar spent on a stock, the average annual return was about 27 cents before taxes.
These are some of the meanings with which the word performance is used :
- Physical : refers to the abilities of an athlete.
- Computational : referring to the way an electronic device works.
- Technological : in relation to technological efficiency.
In economic spheres, the term performance is often replaced by economic profitability , in a clear allusion to the sector to which it refers. It is also regularly replaced by the word productivity , especially when associated with production or manufacturing processes.
Economic performance or economic profitability is used to measure the percentage of profit that a company produces based on the resources used. Therefore, when talking about economic profitability, the investment is a work unit, such as an employee or a work team, and the yield is the profitability obtained from this resource . This percentage does not take into account potential interest or taxes, which would make it a nominal yield . But it does reflect the capital invested as principal.
What does performance depend on?
There are several factors that can affect stock performance, some of which are unpredictable:
- Financial indicators and credit rating of the company (issuer).
- Investments of foreign funds.
- Increase in the indices of the main exchanges, which motivates traders to buy more index funds (ETFs, mutual funds, etc.).
- GDP growth.
- Central Bank interest rate. When it goes down, the stock goes up.
- Rate of inflation.
- Corporate governance.
- currency stability
To calculate how much a stock is undervalued or overvalued, traders also take into account concepts such as:
- Capitalization is the total value of a company’s shares. To assess the attractiveness, it is divided by the benefit and a certain coefficient is obtained. The higher the number, the better. Otherwise, the stock is considered undervalued in the market.
- Benefit. For some analysts, the benefit alone means nothing. They believe that by dividing the capitalization by the size of the free cash flow, the degree of attractiveness of the stock can be determined. The lower the score, the better.
- When it comes to free cash flow, a low ratio indicates that the company has enough free cash left over after paying all taxes. Management can use them to pay dividends or to reinvest in further development. These are the hallmarks of a healthy company.
The average return over time, for example, the last ten years, can also help you. After calculating the result of each year and the total return, you will see a certain pattern.