Where Do Stock Returns Come From?
Peanut butter and jelly. Thelma and Louise. Calvin and Hobbes. Fish and Chips. Wayne and Garth. Some things are better in pairs!
Stock returns consist of two components: dividends and price appreciation. Dividends are paid to shareholders on a quarterly basis from the company’s profits regardless if the stock is up, down or sideways. In addition, investors can profit from price appreciation. Your total return is a combination of the two.
For example, you decide to purchase ABC company at $40 per share. If ABC pays a $1.00 dividend, your current yield will be 2.5% ($1/$40). If you sold your stock at $50, you made 25% ($10/$40). Combining your dividend income with the price appreciation, your total return was 27.5%. If you purchased 1,000 shares, you received $1,000 in income and gained $10,000 giving you a total return of $11,000.
Let’s look at a real-world example. Let’s say you purchased $100,000 worth of Coca-Cola (KO) stock on 8/1/1988 and held it through 8/31/2018. In this example, you generated an annual return of 12.66%. Your $100,000 investment grew to $3.62 million and you received $1.1 million in dividend income. Your dividend income accounted for 31.5% of the total return.
Currently there are 1,269 stocks with a dividend yield of 2% or more. Dividend Aristocrats are companies that have paid, and increased, their dividend for at least 25 years. A few companies on this elite list include: Aflac, Coca-Cola, McDonald’s, Pepsi, Procter & Gamble, Sherwin Williams, Target, and Walmart.
Of course, there are plenty of excellent companies that don’t pay a dividend. Two of the more popular ones are Amazon and Berkshire Hathaway. They plow their profits back into their company rather than pay them to you, the shareholder. In this case, the entire gain comes from price appreciation. Amazon has generated a 10-year average annual return of 38% while Berkshire has returned 10.5% per year over the same time frame.
The key term to focus on is total return. It doesn’t matter how you make money, so long as you make money.
two and two, male and female, went into the ark with Noah, as God had commanded Noah. ~ Genesis 7:9
Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process.
Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog.