capital gains yield
(noun)
compound rate of return of increases in a stock's price
Examples of capital gains yield in the following topics:
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Discounted Dividend vs. Corporate Valuation
- The equation can also be understood to generate the value of a stock such that the sum of its dividend yield (income) plus its growth (capital gains) equals the investor's required total return.
- Consider the dividend growth rate as a proxy for the growth of earnings and by extension the stock price and capital gains.
- Consider the company's cost of equity capital as a proxy for the investor's required total return.
- a) The presumption of a steady and perpetual growth rate less than the cost of capital may not be reasonable.
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Corporations
- Issuing of stock allows corporations to garner large amounts of financial capital.Furthermore, a corporation can raise capital by issuing bonds.A bond is a loan.However, a bond is standardized, allowing investors to buy or sell bonds on the financial markets.Moreover, a bondholder has two rights.First, a corporation pays interest on the bond, regardless of a corporation's financial position.Second, a corporation pays the face value of the bond on a specific date in the future.If a corporation bankrupts or it is dissolved, subsequently, the corporate debts are paid first that include bonds, bank loans, and taxes.If any assets remain,then the preferred stock holders are paid, and finally, the common stockholders are last.
- Stockholders, of course, want a good return for their investment.A return reflects an investor's profit stated in annual percentage terms, and it has two sources: Dividend yield and capital gains.A dividend yield converts the dividend into a percentage.For example, you received $1 per share on your Facebook stock with a value of $20 per share.Dividend equals D; the stock price is P, and t indicates today's time.We calculate your dividend yield as 5% in Equation 1.
- the amount they paid for it.For example, you bought your Facebook stock for $18 per share last year and sold it this year for $20.We compute a capital gain of 11.1% in Equation 2.Notice the subscripts; t represents today while t-1 represents last year.If the investment does not exactly equal one year, then we must adjust the capital gain.For instance, if your investment lasted for two years, subsequently, you would divide the capital gain by 2, converting it into an annual return.
- Your return from your Facebook investment is the dividend yield plus the capital gain, or 16.1%.Corporate managers can influence the dividend yield that ranges approximately 2% per year while they have little influence on the capital gains that could range as high as 12% per year.Unfortunately, investors could face catastrophic losses if a stock market quickly plummets during a downturn in an economy.For example, the U.S. stock markets dropped half in value during 2008, and many internet stocks became worthless during 2000 as the stock from internet companies plummeted.Consequently, investors could earn capital losses if they sell their stock as it falls in value, or the corporation bankrupts.
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Institutions, Markets, and Intermediaries
- Other financial intermediaries include: credit unions, private equity, venture capital funds, leasing companies, insurance and pension funds, and micro-credit providers.
- As noted, financial intermediaries provide access to capital.
- By repurposing funds from savers to borrowers financial intermediaries are able to promote economic growth by providing access to capital.
- Additionally, through diversified lending practices, banks are able to lend monies to high-risk entities and by pooling with low-risk loans are able to gain in yield while implementing risk management.
- Banks convert deposits to loans and thereby increase access to capital by serving as a financial intermediary between savers and borrowers.
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Yield to Maturity and Rate of Return
- If investors hold the bond until maturity, then we call the discount rate the yield to maturity.Economists consider yield to maturity the most accurate measure of the interest rates because the yield to maturity allows investors to compare different bonds.For example, you want to buy a coupon bond today for a market price of $1,600.Bond pays $400 interest per year and matures in three years.Finally, the bond pays $1,000 on the maturity date.Consequently, we calculate your yield to maturity of 14.11% in Equation 6.You can compare this yield toother investments and choose the investment with the greatest yield.
- Yield to maturity generates two important rules on bonds, which are:
- Market interest rate (or yield to maturity) and the market price (or present value) of the securities are inversely related.For example, if you examine the present value formula, the interest rate, or yield to maturity is located in the denominators of the fractions.Thus, the market price falls as the interest rate rises, and vice versa.
- You can become confused by the terms used throughout this book.We use yield to maturity, discount rate, and interest rate interchangeably, and you can interpret these terms to mean an interest rate.However, a rate of return differs because investors could sell their securities before they matured.Thus, the rate or return includes the interest rate and capital gains or losses.A capital gain is an investor sells a financial security for greater price, while a capital loss is an investor sells a financial security for a lower price.Investors do not want capitallosses, but they can occur.For instance, an investor must sell an asset whose market price has dropped because he or she needs cash quickly.Thus, the present value still works for capital gains and losses.Finally, if the investor holds onto the security onto the maturity date, then the rate of return equals the yield to maturity.
- A bond, for example, has a face value of $2,000 with a coupon interest rate of 5% and a 10- year maturity.You bought this bond for $2,000 and then resold it two years later for $2,400.Thus, you collected two years of interest.Consequently, your rate of return equals the two years of interest plus the capital gain of 14.33%.We calculated the capital gain in Equation 10, and r equals the rate of return.The author used a computer program to solve for r.
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Dividend Irrelevance Theory
- Under perfect market conditions, stockholders would ultimately be indifferent between returns from dividends or returns from capital gains.
- Dividend irrelevance follows from this capital structure irrelevance.
- However, the total return from both dividends and capital gains to stockholders should be the same.
- Therefore, if there are no tax advantages or disadvantages involved with these two options, stockholders would ultimately be indifferent between returns from dividends or returns from capital gains.
- Since the publication of the papers by Modigliani and Miller, numerous studies have shown that it does not make any difference to the wealth of shareholders whether a company has a high dividend yield or if a company uses its earnings to reinvest in the company and achieves higher growth.
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Performance per Share
- Valuation ratios describe the value of shares to shareholders, and include the EPS ratio, the P/E ratio, and the dividend yield ratio.
- The dividend yield or the dividend-price ratio of a share is the company's total annual dividend payments divided by its market capitalization—or the dividend per share, divided by the price per share.
- Current Dividend Yield = Most Recent Full Year Dividend / Current Share Price.
- However, investors seeking capital growth may prefer a lower payout ratio, because capital gains are taxed at a lower rate.
- In the first method, the company's market capitalization can be divided by the company's total book value from its balance sheet (Market Capitalization / Total Book Value).
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Value of a Low Dividend
- Furthermore, retained earnings lead to long-term capital gains, which have taxation advantages over high dividend payouts, according to the Taxation Preference Theory.
- Taxes on capital gains are deferred into the future when the stock is actually sold, as opposed to immediately like cash dividends.
- Furthermore, capital gains are taxed at lower rates than dividends.
- A history of low or falling yields may indicate that the firm's cash situation is not stable.
- Conversely, a low dividend yield can be considered evidence that the firm is experiencing rapid growth or that future dividends might be higher.
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Dividend Yield Ratio
- The dividend-price ratio is a company's annual dividend payments divided by market capitalization, or dividend per share divided by the price per share.
- The dividend yield or the dividend-price ratio of a share is the company's total annual dividend payments divided by its market capitalization, or the dividend per share, divided by the price per share.
- The historic yield is calculated using the following formula:
- The yield for the S&P 500 is reported this way.
- Some investors may find a higher dividend yield attractive, for instance, as an aid to marketing a fund to retail investors, or maybe because they cannot get their hands on the capital, which may be tied up in a trust arrangement.
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The Yield Curve
- Based on the shape of the yield curve, we have normal yield curves, steep yield curves, flat or humped yield curves, and inverted yield curves .
- The yield curve is normal meaning that yields rise as maturity lengthens (i.e., the slope of the yield curve is positive).
- However, rates begin to rise once the demand for capital is re-established by growing economic activity.
- An inverted yield curve occurs when long-term yields fall below short-term yields.
- Because of the term premium, long-term bond yields tend to be higher than short-term yields, and the yield curve slopes upward.
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Return on Investment
- Return on investment (ROI) is one way of considering profits in relation to capital invested.
- Suppose a lemonade stand wanted to use a yield management method.
- Return on assets (ROA), return on net assets (RONA), return on capital (ROC) and return on invested capital (ROIC) are similar measures with variations on how 'investment' is defined .
- Return on investment = (gain from investment - cost of investment) / cost of investment
- Return on assets (ROA), return on net assets (RONA), return on capital (ROC) and return on invested capital (ROIC) are similar measures with variations on how 'investment' is defined.