Understanding total returns

It takes into consideration intervening cashflows and price appreciation

Investors are used to calculating the returns from their investment in shares only in terms of capital appreciation or just price returns. The dividend return gets completely ignored in this process, or the dividend yield is calculated separately to assess the attractiveness of the share in terms of the dividends that it can give out. However, these two aspects can be combined to truly assess the returns from an investment. Enter, total returns.

Let’s take the information technology space. Top players such as TCS, Infosys, HCL Technologies and Wipro operate similar businesses. All these companies pay their shareholders hefty dividends, too. If we take the past six years, since June 2013, if you had invested in 1,000 shares of any of the four companies, without considering dividends, TCS, Infosys, HCL Technologies and Wipro gave returns (adjusted for bonus, stock splits) of 19.8 per cent, 16.1 per cent, 19.3 per cent and 15.3 per cent, respectively. When we include the dividends paid by the companies, the returns turn out to be 22.1 per cent, 18.9 per cent, 21.4 per cent and 16.7 per cent, respectively.

Total returns allow you to assess how much your wealth has multiplied by over the years, taking into consideration intervening cashflows and price appreciation. The total return calculation assumes that the amount earned as dividend by the investor is reinvested in the same stock. This becomes even more important when analysing the compounded returns on your investment over multiple years.

Alternatively, you can take the price appreciation in percentage terms and add it to the dividend yield to calculate the total return from a stock.

Total returns for stocks

You can use total returns to compare the returns of stocks in a homogeneous industry. While some stocks with strong growth prospects may show good price appreciation, others may be consistently good dividend payers.

Calculation of total returns will put them on an even keel. Total returns also become relevant in sideways markets when price returns are not substantial.

In case a company also buys back its shares from investors, there is an adjustment an investor can make while calculating total returns. This would be in addition to the adjustment made for dividends received over the years.

Total return in mutual funds

The importance of the total return as the right measure to assess returns was demonstrated last year when the markets regulator Securities Exchange Board of India (SEBI) ordered all mutual fund schemes to benchmark the returns of their schemes to the respective total returns index rather than the price return index.

For instance, the Nifty 50 is a regular index, while the Nifty 50 Total Return Index captures all the dividend payments of the companies that form part of the Nifty 50.

The net asset value of the funds are also adjusted for dividends to give the true picture of the returns.

One can use many calculators available on the internet to calculate total returns. However, do remember that this is just an additional tool to evaluate stock performance.

Keep in mind what your investment goals are before using total returns to evaluate past performance.

Read the rest of this article by Signing up for Portfolio.It's completely free!

What You'll Get

This article is closed for comments.
Please Email the Editor