When comparing dividend stocks it is important to look at Total Return performance charts and not just price charts, which is often the case. Dividends contribute to more than one-third of the long-term total return from equity investments, so important to factor-in. (See: Why are dividends important?)
What Is Total Return?
The total return is the full return of an investment over a given time period. It includes all capital gains and any dividends paid.
As indicate total returns differs from stock price growth because of dividends. Total return differs from stock price growth because of dividends. The price return of a stock going from $100 to $110 is 10%. The total return of a stock going from $100 to $110 and paying $3 in dividends is 13%.
The formula is quite simple and presented below:
Example of the Stock Total Return Formula
How to calculate the total return for a dividend stock:
- Find the stock price at the start (initial share price)
- Find the total amount of dividends paid during the investment period
- Find the closing price of the stock
- Add the sum of dividends to the closing price minus the starting price
- Divide this number by the starting price
Using the numbers from above and the Stock Total Return Formula will give the following calculation:
P-start= $100
P-end= $110
Dividends = $3
Total return = (($110-$100)+$3) / $100 = 13%
Let’s calculate the 3 years total return and price return for the dividend stock 3m (MMM) on august 30th 2019.
Closing price on 2016-08-30 is $180.15 (P-start)
Closing price on 2019-08-30 is $161.72 (P-end)
This will result in a price return of -10.23%
3M paid after august 30th 2016 the following dividends:
2016 : $1.11
2017 : $4.70 (Quarterly $1.175)
2018 : $5.44 (Quarterly $1.36)
2019 : $4.32 (3 quarters $1.44)
In total, the dividends paid are $15.57.
Closing price on 2016-08-30 is $180.15 (P-start)
Closing price on 2019-08-30 is $161.72 (P-end)
This will result in a total return of -1.59%, which is significantly better than the price return.
Compound Annual Growth Rate – CAGR
The total return including dividends is important when comparing the performance of dividend stocks. Investors can compare the performance even better by using the CAGR. The CAGR can be used to evaluate how well one stock performed against other stocks in a peer group or against a market index, in addition, also different time periods (3, 5,10 years) are easy to compare.
To calculate the CAGR of an investment: Divide the value of an investment at the end (V-end) of the period by its value at the beginning of that period(V-start). Raise the result to an exponent of one divided by the number of years.
Returning to the 3M example the values are:
Closing price on 2016-08-30 is $180.15 (V-start)
Closing price on 2019-08-30 is $161.72
Dividends paid are $15.57,so V-end is $177.29 ($161.72 + $15.57)
The CAGR for 3M (MMM) for the 3 years period is ($177.29/$180.25)^ (1/3) -1 results in -0.53%.
The total returns for MMM and other dividend stocks are calculated for a 3, 5, and 10 years period and available via the detailed overview page like 3M (MMM)
Alternative Total Return Methods
The total return price allows investors to view the performance of a security combining both price appreciation and dividends distributions. The way how to include dividend (or the assumption that all dividends are reinvested) can vary. Some total return methods use the approach to invest the dividends received against the opening price after the dividend payment date.
Other adjust the price on dividend ex-date by reducing the price prior to the dividend payment by applying a dividend adjustment factor calculated as (1 – Value of Dividend/ Previous Day’s Close Price).
The formula, in this case, is: Total Return Price = Actual Price x Dividend Adjustment Factor
Please note that dividend factors are cumulative, so a stock that paid quarterly dividends during a year, will have 4 Dividend Adjustment Factors. On top, stocks splits should be taken into account and by default (dividend) taxes are excluded from the calculations.