Total shareholder return is the amount of additional money earned for every dollar invested. There are a few ways to see how much an investor earns beyond just looking at how much the share has gone up in price.
Learn how to figure out your return based on income variables.
Definition and Examples of Total Shareholder Return
In broad terms, total shareholder return is how much added money you get for every $1 invested. The source of that added money doesn't matter. To figure it out, you must understand those varied sources of income.
There are more than a couple of ways to find out how an investment performs. A common mistake in the investment process, especially among new investors, is focusing solely on capital gains rather than total shareholder return. This is an easy trap to fall into if you're new to stocks, bonds, real estate, mutual funds, or small business investments.
For instance, what if people bought one share of XYZ stock for $15? In one year, the new price of that stock is $20. They also made $2.50 in dividends over that time. This means they would look to find out how much additional money they made from all sources compared to how much they invested.
While it may be easy to see in a simple example like this, the total shareholder return can be even more useful when higher amounts of money are invested.
How to Find the Total Shareholder Return
It may seem like you can figure out the total return simply by looking at the value of stock when it was bought compared to its price today. But there's more that goes into it. To perform a full calculation, you'll need to include dividends, along with:
- The value of any shares you got from a spin-off company.
- The value of the dividends from the spin-off.
- The value of any shares that were liquidated and converted to cash.
- Any other cash you got from the stock.
To get the total shareholder return, add all of those along with the difference between your initial cost basis purchase value and the current stock value. You could then convert this to a percentage ROI by dividing the result by your initial cost basis.
This formula can get a little more complex when spin-offs are part of the deal. Your broker might adjust the tax cost basis on your initial investment and assign a portion of that to the spin-off. If you want to use those figures, you'd need to change the numbers accordingly. You would need to subtract the adjusted cost basis of the spun-off stock from the end market value of the spun-off stock, then add that result to your total shareholder return.
In complex cases, you might end up having to do a lot of math across a dozen or more companies to retroactively find your total return. The end result is much more informative than simply looking at how the price has changed since you first bought the stock.
Don't Confuse Return Formulas
The total shareholder return formula method many firms use in their annual report, 10-K filing, or proxy statement differs. Those total shareholder return charts seek to answer the question, "How much money would an investor have made if, at one year, five years, 10 years, and 20 years in the past, they had bought our stock, held it, and reinvested all dividends?" A comparable total return figure is found for the firm's peer group (competitors, in many cases) and the S&P 500 stock market index to show how much better or worse its stock would do.
5 Major Sources of Total Shareholder Return
Historically, total shareholder return has come from a handful of sources.
When you buy a stock at one price and it goes up, the difference is known as a capital gain. For the tiny minority of firms that have never paid dividends or issued a stock split, this is the primary, often sole, source of total shareholder return. Warren Buffett's holding company, Berkshire Hathaway, falls into this group.
For large firms making a profit, dividends have been shown to be the primary driver of nearly all inflation-adjusted total shareholder returns.
When a firm chooses to shed a unit or function that no longer fits with its focus or goals, it's common to have the spin-off become its own publicly traded enterprise. The firm may send owners shares of the spin-off as a special distribution. These stock spin-offs can be one of the best sources of total shareholder return.
Recapitalization or Buyout Distributions
The capitalization structure of a firm is vital. When economic climates change, owners can increase their wealth by making changes to the current structure. This can free up equity that had been tied up in the firm. This newly freed money, replaced by cheap debt, gets shipped out the door to owners. Owners can then spend, save, donate, gift, or reinvest it.
Though they made a brief comeback during the credit crisis, stock warrant distributions are not common these days. When they were more common, firms might create warrants and distribute them to existing stockholders. These warrants behaved like stock options. They gave the holder the right, but not the duty, to buy more shares at a fixed price within a certain date range. But when they were exercised, the firm would print new stock certificates and increase the total number of shares outstanding, taking the warrant premium for the corporate treasury.
Looking at Total Return for a Real Blue Chip Stock
Let's look at the value of total shareholder return in a real-life instance. Let's say you had purchased 2,300 shares in PepsiCo at $44.38 per share in the early 1980s, for a total cost of $102,074.
A chart of PepsiCo's stock would make it appear that the position, following three stock splits—a three-for-one split on May 28th, 1986, a three-for-one split on September 4th, 1990, and a two-for-one split on May 28th, 1996—would have turned the 2,300 shares into 41,400 shares. If you had sold this stock in 2015, it would have been worth $4,098,600.
But, as good of a return as that is, it does not show the actual total shareholder return. It still leaves out three sources of added wealth creation that would not have shown up in most stock charts.
- Over those 32+ years, PepsiCo would have paid you $1,058,184 in cash dividends.
- In the fall of 1998, PepsiCo divested its restaurant division, which owned franchises such as KFC, Taco Bell, and Pizza Hut. This spin-off business was called Tricon Global Restaurants. The investor would have received an initial block of 4,140 shares that were split two-for-one on June 18th, 2002, and again on June 27th, 2007. The result would be having 16,560 shares of Yum! Brands (the new name), which had a current market value of another $1,354,608.
- On top of this, Yum! Brands paid out cash dividends of $148,709 on its shares.
Combined, this means the PepsiCo investor had an extra $2,561,501 in wealth on top of the $4,098,600 in PepsiCo shares. That is almost 63% more money. If that doesn't convince you that total return is what really matters, nothing will.