How To Calculate Expected Total Return For Any Stock

Initially printed July sixteenth, 2016 by Ben Reynolds

Up to date on September twenty seventh, 2024

The aim of rational traders is to maximise complete return beneath a given set of constraints.

Constraints embody:

Danger tolerance
Present earnings wants
Moral considerations (no tobacco shares, for example)

This text reveals precisely tips on how to calculate anticipated complete returns.

Word: The Dividend Aristocrats are an elite group of 66 shares within the S&P 500 which have paid rising dividends for 25+ consecutive years.

You may obtain an Excel spreadsheet of all 66 (with metrics that matter corresponding to dividend yields and price-to-earnings ratios) by clicking the hyperlink beneath:

What Is Complete Return?

Complete return is the whole return of an funding over a given time interval.  It contains all capital positive factors and any dividends or curiosity paid.

Complete return differs from inventory worth development due to dividends.  The entire return of a inventory going from $10 to $20 is 100%.

The entire return of a inventory going from $10 to $20 and paying $1 in dividends is 110%.

It could appear easy at first look, however complete returns are probably the most necessary monetary metrics round…

How-To Calculate Complete Return

Discover the preliminary price of the funding
Discover complete quantity of dividends or curiosity paid throughout funding interval
Discover the closing gross sales worth of the funding
Add sum of dividends and/or curiosity to the closing worth
Divide this quantity by the preliminary funding price and subtract 1

An instance utilizing the numbers from the dividend case within the ‘What Is Complete Return’ part is beneath:

$10
$1
$20
$20 + $1 = $21
$21 / $10 – 1 = 110%

How-To Estimate Future Complete Return

Calculating complete return after the actual fact is straightforward.

There’s cash to be made in precisely estimating anticipated future complete returns within the inventory market.

To know how to do that for shares, now we have to interrupt complete return down into its parts.

Dividends
Change in share worth

Change in share worth comes from 2 sources.

Change in earnings-per-share (or much less generally e-book worth, income, and so forth.)
Change in price-to-earnings a number of (or different valuation a number of)

Subsequently, the three facets of complete return for shares are:

Dividends
Change in earnings-per-share
Change in price-to-earnings a number of

The components for anticipated complete return is beneath:

Anticipated complete return = change in earnings-per-share x change within the price-to-earnings ratio

Word: We calculate anticipated complete returns utilizing the three facets of complete return for greater than 600 securities in The Positive Evaluation Analysis Database.

The remainder of this text reveals tips on how to estimate anticipated complete returns with a real-world instance.

We’ll estimate future returns for Coca-Cola (KO) over the subsequent 5 years.

Coca-Cola is used for example as a result of it’s a comparatively easy, predictable enterprise.  This makes it a good selection for studying tips on how to calculate anticipated complete returns.

With that mentioned, this technique could be utilized to any inventory funding.

The additional out in time one estimates, the much less dependable the estimate.  Estimates of Coca-Cola’s return over 1 12 months will probably be extra correct than estimates over 10 or 20 years as a result of extra can change in 10 or 20 years than in 1 12 months.

Estimating Valuation A number of Modifications

Coca-Cola inventory at the moment trades for ~$71 per share.  The corporate is predicted to generate adjusted earnings-per-share of $2.85 for 2024, for a price-to-earnings ratio of roughly 24.9.

Prior to now 10 years Coca-Cola had a mean price-to-earnings ratio of 23.1.

In the meantime, S&P 500 shares seem like overvalued from a historic perspective at present ranges.

There are 2 questions encompass Coca-Cola’s price-to-earnings ratio:

Will it keep its valuation premium in contrast with its 10-year common?
Will the market nonetheless be overvalued in 5 years?

When one makes projections, one ought to at all times err on the aspect of warning.

Coca-Cola’s core soda enterprise is experiencing headwinds in developed international locations which can be prone to persist indefinitely.  Alternatively, the corporate is a market chief that also has development potential internationally and with its nonetheless drinks.

Given all these components, we imagine a price-to-earnings ratio of 23 is suitable for Coca-Cola inventory.

The query of whether or not the market as an entire can be overvalued in 5 years is harder to reply.

Listed below are 3 totally different eventualities for the subsequent 5 years:

Market reverts to historic price-to-earnings ratio of 16.0
Market maintains its present overvalued standing at 29.9
Market mediates to a price-to-earnings ratio of round 20

I imagine that each one 3 of those eventualities are about equally probably. That is simply guessing on the future. Estimating a dependable price-to-earnings ratio into the longer term is error-prone.

Nonetheless, since KO inventory is buying and selling above our truthful worth estimate, we anticipate that valuation a number of adjustments can be a drag on Coca-Cola’s future returns.

If the P/E a number of declines from 24.9 to 23 over the subsequent 5 years, it will cut back complete returns by 1.6% per 12 months over that point interval.

The steps to calculate valuation a number of adjustments are beneath:

Discover present price-to-earnings ratio
Estimate anticipated future price-to-earnings ratio
Calculate compound annual development price of price-to-earnings ratio

Estimating Anticipated Development Price: Underlying Enterprise Development

Development needs to be estimated on a per share foundation.

Why? As a result of share buybacks and issuances matter. A quick instance is beneath:

Think about a enterprise generated $1,000,000 a 12 months and has 4 house owners. This enterprise is valued at a 10x earnings a number of.  The entire enterprise is value $10,000,000.  Your share of the enterprise is value $2,500,000 (fortunate you!).

Now think about that one of many house owners needs to be ‘purchased out’.  The enterprise makes use of money readily available to purchase out this proprietor.  There are actually solely 3 house owners left, and the enterprise continues to be making $1,000,000 a 12 months and has a 10x a number of.

Your share of the enterprise has now gone as much as $3,333,333 since you personal 33% of it as an alternative of 25%.

If new shares had been issued, the other impact would have occurred; your shares could be value much less.  Buyers ought to at all times estimate development on a per share foundation.

Development comes from 2 locations for public companies:

Share repurchases
Underlying enterprise development

We’ll assume foreign money fluctuations can be flat over the rest of Coca-Cola’s 5 12 months projections. The corporate has quite a few favorable development prospects working for it, in addition to unfavorable soda traits working towards it within the developed world.

We anticipate the corporate to proceed rising EPS at round 7% a 12 months going ahead. This plus the -1.6% per 12 months price-to-earnings ratio compression means we’re at anticipated complete returns of round 5.4% a 12 months earlier than dividends.

Estimating Dividend Funds

Coca-Cola at the moment has a dividend yield of two.7%.  The fast and (largely) appropriate strategy to discover the quantity of return dividends will add to complete return is to easily add the present dividend yield to our return numbers to date.

Including Coca-Cola’s present dividend yield of two.7% to the 5.4% returns we’ve calculated to date offers us an anticipated complete return of 8.1% a 12 months.

Including present yield doesn’t consider dividend development. Coca-Cola is one in all solely 50 Dividend Kings; shares with over 50 consecutive years of dividend will increase.  The corporate’s dividend will very probably proceed to develop.

As talked about earlier, we anticipate dividend funds (not on a per share foundation) to develop barely beneath the speed of EPS development, at 6% a 12 months.

Placing It All Collectively

If you have a look at the place complete returns will really come from you’ll be able to higher estimate how a lot you anticipate to make from an funding.

This lets you extra precisely examine investments to one another.

Once we analyzed Coca-Cola, we got here up with an estimated complete return of 8.1% a 12 months.  Chances are you’ll assume the corporate will develop earnings at 8% a 12 months as an alternative of seven%, or that its truthful price-to-earnings ratio is absolutely 30.

This may improve anticipated complete returns.  It’s necessary to make your judgment as sober as attainable when evaluating complete returns of companies.

Replace from 2024: With the advantage of hindsight, we are able to see how shut the anticipated complete return calculations had been to actuality. Wanting again, the assumptions on the time this text was first printed appeared legitimate. From August 1st, 2016 (the beginning of the primary month after this evaluation was written) by way of July thirty first, 2021 (5 full years), Coca-Cola inventory generated complete returns of 9.1% on an annualized foundation. This was practically 3 share factors forward of our estimate from 2016.

The ‘fast and straightforward’ strategy to discover complete return is to:

Calculate return from change in price-to-earnings a number of
Add in present dividend yield
Add in anticipated enterprise development price on a per share foundation

This technique will present very comparable estimates with out practically as a lot ‘quantity crunching’ as within the instance above.

Complete return is one in all (if not the) most necessary monetary metrics round.  Complete returns (by way of development and dividends) are an necessary a part of The Positive Dividend Investing Methodology.

This text wouldn’t be full with out offering some assets for present and historic information.

Alternatively, you’ll be able to see our estimates for anticipated complete return and its three parts (dividend yield, development on a per share  foundation, and valuation ratio change) in The Positive Evaluation Analysis Database.

Positive Dividend maintains comparable databases on the next helpful universes of shares: