The capital gains yield (CGY) formula calculates the change in stocks’ (or other securities) prices over a given time period. CGY formula doesn’t take into account any dividends and is based only on stock price appreciation.
CGY should be analysed before making a decision whether to buy shares of a given company. It provides important information for shareholders because it tells whether the investor would get any return on the stock price appreciation. Many investors calculate a security’s capital gains yield because the formula shows how much the price fluctuates. This helps an investor to decide which securities are a good investment. Usually, securities with higher risk have bigger price fluctuations, which give investors an opportunity to potentially achieve above-average returns, but there’s a risk of not receiving any returns at all.
How to calculate capital gains yield?
Capital gains yield is calculated as:
Capital\;Gains\;Yield = \frac{P_{1} - P_{0}}{P_{0}}Where P1 is a current market price of the security and P0 is an original price of the security or, in other words, a purchase price.
This formula compares the beginning share price and the share price at the ending of the period. The result of the comparison is described as a percentage of the differences on the basis of the beginning stock price.
Capital gains yield analysis
Capital gains yield can be positive or negative. However, an investment that has a negative CGY may generate profits for an investor, for example, if a company pays high dividends. Then capital gains yield can be lower because all the profit would be generated by the dividends. Other stocks have higher capital gains yield, but no dividends at all.
Examples of capital gains yield calculation
Example 1
- Let’s assume an investor buys a share of company ABC at a market price of $110.
- After one year, the market price of a share of company ABC increases to $130.
- An investor sells the share. What is the capital gains yield?
Example 2
- Let’s assume an investor buys a share of company XYZ at a market price of $110.
- After one year, the market price of a share of company ABC decreases to $90.
- An investor decides to sell the share because he expects further prices decreases. What is the capital gains yield?
Use of capital gains yield formula
Capital gains yield is an important measure for every investor because it shows whether the investor would get any return on the stock price appreciation. However, it can be used only if he doesn’t receive any dividends. If a company pays dividends, an investor may consider calculating not only capital gains yield but also a dividend yield and a total stock return. A dividend yield is calculated by dividing the annual dividend by the share price. Total stock return takes into account changes in stocks’ prices (capital gains yield) plus dividends paid over a given time period (dividend yield). There are many methods of total stock return calculation. One of them is simply adding capital gains yield and dividend yield.
For example, if an investor wants to compare two investments:
Investment 1
- The initial price of ABC Company’s stock is $10.
- By the end of the year an investor decides to sell the stock for $15.
- ABC company doesn’t pay any dividends.
Then the investor can use the capital gains yield formula since there are no dividends.
Capital\;Gains\;Yield = \frac{\$15 - \$10}{\$10} = 50\%Capital gains yield in this case is 50%. Total stock return will also be 50% since the dividend yield is 0.
Investment 2
- The initial price of XYZ Company’s stock is $10.
- By the end of the year an investor decides to sell the stock for $13.
- ABC company paid 10% of dividends during the holding period.