#shareholder value is a fairly tangible concept that many people can relate to and apply on their own stock portfolio’s once understood.
It starts off by saying that #investors always want a return for their investment. Investors tend to have different #risk appetite but in general the rule is that the higher the risk of the investment the higher the return is desired. If you put your #money on a bank you likely expect a lower interest rate than when you invest in a venture capitalist who buys and sells companies.
Total Shareholder Return is derived as follows and consists of 2 components:
1. #share #price Increase
A stock today worth 25 and tomorrow 35 means a 40% return over one year . Stock #prices move based on the #demand for a certain stock, but there are many factors influencing the stock price (including factors outside of #control of the company you are investing in). What is important to know is that this return is not paid-out by the company in #cash. Only when the investor decides to sell his stock he can say he realized a gain or a loss on that stock. The share price increase therefore doesn’t say anything about the cash position of an investor.
The share price increase is calculated by dividing the new price of the stock -/- old price divided by the old price.
E.g. a stock prices 10 a year ago, now costs 12 is a 20% increase.
2. Dividend Yield
The second element of share holder value is dividend. Dividend is a portion of the #profit paid out to the share holder, i.e. the company rewards the shareholder for investing in its company. Some companies do not pay dividend at all, think about those Tech companies that surged the market aroudn 2000’s, they never made a profit and intended to make the share holder rich by promising future share price increases, not dividends. More traditional companies do not work like that. Pension companies and insurance companies invest in the stock market not to make a share price increase but to get a #long term sustainable stream of cash from its investments, precisly what dividend gives. Dividends can be therefore considered a #fixed income (sort of like
interest on a bank loan).
Stocklisted companies use their dividend policy as a mechanism to boost confidence in the market. It is considered a poor “signal” to the market if a company reduces or even does not pay out dividends. Companies that have cut their dividends in the past have seen their share prices plummet. It can therefore be considered as a steady stream of income.
The dividend payout is calculated as a percentage of the price of the stock.
E.g. paying $5 dividend on a $50 share price = 10% return
The two concepts combined is % return for the shareholder. In this example the current year’s shareholder value created is 30% (share price increase of 20% + dividend yield of 10%)
Practically you can apply this to your own stock portfolio. In comparing a return the investor will always look at the risk of this investment. In a market environment where 4% interest on a savings account is common, a 30% return likely means this investment is likely highly risky.