Welcome back to another edition of "Speaking Mathanese," our Motley Fool series that tackles financial math myths, deconstructing the computations that make the biggest difference to your bottom line.
This week, our quest to make you smarter than a fifth-grader takes us from the delightful den of the dividend yield to the tantalizing topic of total return.
The myth
First, the question behind this week's lesson:
How do you calculate "total return" for a stock you have owned for several months, and which pays a dividend?
Good question. The answer largely has to do with how you collect your dividends, and what sort of account you have. (There's this thing called "taxes" you have to pay if you own shares outside of a retirement account.)
Basics first, though. What is total return? A shopping spree that ends badly? "None of this stuff fits! Looks like we'll have to do a total return. Kids, get in the car, we're going to Target!"
The math
Not exactly. Total return, measured on a percentage basis, is your gains on a stock purchase above and beyond your cost basis.
If you're wondering why we calculate this on a percentage basis, well, that's how the broader market's returns are measured. As investors, our primary goal should be to earn more than we could holding modest positions in stocks like Chevron (NYSE:CVX), Hewlett-Packard (NYSE:HPQ), or Verizon (NYSE:VZ) via an index fund.
On to the math. First, you'll need to calculate the cash value of your holdings. Let's say you own 100 shares of Acme Rockets (Ticker: ZOOOM), which you bought for $2,500. Let's also say that you've earned $200 in dividends from your holdings, and that your shares are now worth $50 apiece. Your cash value is $5,200. (100 shares at $50 per share is $5,000, plus $200 in dividends equals $5,200.)
And your total return? Drumroll, please:
((Current value / cost basis)-1) * 100
So, your investment in Acme Rockets has returned 108%. ($5,200 / $2,500 = 2.08-1 = 1.08 * 100 = 108%.)
We subtract 1 from 2.08 because a 100% return is the same as doubling your money. Here, Acme would have had to rise to $7,700 in cash value to produce a 208% return. ($7,700 / $2,500 = 3.08-1 = 2.08 * 100 = 208%.)
Questions? Submit them here. Otherwise, I'll see you next week when we reveal the intricacies of the compound annual growth rate.
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Fool contributor Tim Beyers writes weekly about personal finance and investing basics. Have a Foolish money tip? Tell him. Tim didn't own shares in any of the companies mentioned in this article at the time of publication. Tim's portfolio holdings can be found at his Fool profile. His thoughts on personal finance, Foolishness, and investing in general may be found in his blog. The Motley Fool's disclosure policy is lobbying its local school district for a course in beginning mathanese.
