There are many ways to find out how an investment performs. One common mistake in the investment process, especially among new investors, is focusing solely on capital gains rather than total shareholder return. That is an easy trap to fall into if you’re new to stocks, bonds, real estate, mutual funds, or small business investments. Imagine you bought one share of XYZ stock for $15, and it performed well. At the end of the year, the new price of that stock is $20. That $5 is the capital gain on your investment. However, if you also made $1 in dividends from that stock over that time, the $5 doesn’t represent the whole of your added money. Total shareholder return requires understanding all the sources of asset growth you have from a single investment, and then comparing that total to how much you invested. While that may be easy to see in a simple example like the one above, the total shareholder return can be even more useful when larger amounts of money and more complex investments are involved.
How Do You Calculate Total Shareholder Return?
Comparing the value of a stock when it was bought to its price today can tell you a lot about the return on your investment, but it doesn’t give you the total shareholder return. To perform a full calculation, you’ll need to include all other earnings from the stock since you bought it, including the value of any:
DividendsShares from a spin-off companyDividends from a spin-offShares that were liquidated and converted to cashOther cash you got from the stock
To get the total shareholder return, subtract your initial cost basis from the current value of the stock. Then add all of the other earnings you have from the stock in that time (such as dividends). You could then convert this to a percentage ROI by dividing the result by your initial cost basis. This formula can get a little more complex when spin-offs are involved. Your broker might adjust the tax cost basis on your initial investment and assign a portion of that to the spin-off. If you want to use those figures, you need to change the numbers accordingly. You would need to subtract the adjusted cost basis of the spun-off stock from the end market value of the spun-off stock, and then add that result to your total shareholder return. In complex cases, you might end up having to do a lot of math across a dozen or more companies to retroactively find your total return. The end result is much more informative than simply looking at how the price has changed since you first bought the stock.
How Total Shareholder Return Works
Historically, total shareholder return has come from a handful of sources.
Capital Gains
When you buy a stock at one price, and it goes up, the difference is known as a “capital gain.” For firms that have never paid dividends or issued a stock split, this is the primary or sole source of total shareholder return. Warren Buffett’s holding company, Berkshire Hathaway, falls into this group.
Dividends
When a firm creates net income, it may decide to take some of that money and give it to stockholders so they can enjoy the fruits of their financial risk. This money is called a dividend.
Spin-Offs
When a firm chooses to shed a unit or function that no longer fits with its focus or goals, it’s common to have the spin-off become its own publicly traded enterprise. The firm may send owners shares of the spin-off as a special distribution. These stock spin-offs can be one of the best sources of total shareholder return.
Recapitalization or Buyout Distributions
The capitalization structure of a firm is vital. When economic climates change, owners can increase their wealth by making changes to the current structure. That can free up equity that had been tied up in the firm. This newly freed money, replaced by cheap debt, is given to owners, who can then spend, save, donate, gift, or reinvest it.
Warrant Distributions
Though they made a brief comeback during the credit crisis, stock warrant distributions are not common these days. When they were more common, firms might create warrants and distribute them to existing stockholders. These warrants behaved like stock options. They gave the holder the right, but not the duty, to buy more shares at a fixed price within a certain date range. But when they were exercised, the firm would print new stock certificates and increase the total number of shares outstanding, taking the warrant premium for the corporate treasury.
Example of Calculating Total Shareholder Return
Let’s look at the value of total shareholder return in a real-life instance. Imagine that you had purchased 2,300 shares of PepsiCo at $44.38 per share in the early 1980s, for a total cost of $102,074. A chart of PepsiCo’s stock would make it appear that the position, following three stock splits—a three-for-one split on May 28th, 1986; a three-for-one split on September 4th, 1990; and a two-for-one split on May 28th, 1996—would have turned the 2,300 shares into 41,400 shares. If you had sold this stock in 2015, it would have been worth $4,098,600. As good of a return as that is, it does not show the actual total shareholder return. It still leaves out three sources of added wealth creation that would not have shown up in most stock charts.
Over those 32-plus years, PepsiCo would have paid you $1,058,184 in cash dividends.In the fall of 1998, PepsiCo divested its restaurant division, which owned franchises such as KFC, Taco Bell, and Pizza Hut. This spin-off business was called Tricon Global Restaurants (later renamed Yum! Brands). You would have received an initial block of 4,140 shares that were split two-for-one on June 18th, 2002, and again on June 27th, 2007. The result would have been having 16,560 shares of Yum! Brands, which had a current market value of another $1,354,608. On top of this, Yum! Brands paid out cash dividends of $148,709 on its shares.
Combined, this means that you would have an extra $2,561,501 in wealth on top of the $4,098,600 in PepsiCo shares. That is almost 63% more money.
Limitations of Total Shareholder Return Formula
Many firms use a different total shareholder return formula in their annual report, 10-K filing, or proxy statement. Those total shareholder return charts seek to answer the question, “How much money would an investor have made if, at one year, five years, 10 years, and 20 years in the past, they had bought our stock, held it, and reinvested all dividends?” A comparable total return figure is found for the firm’s peer group (competitors, in many cases) and the S&P 500 stock market index to show how much better or worse its stock would do.
