How to Calculate the Total Shareholder Return Formula

Don't Focus Solely on Capital Gains Or You'll Understate Your Investment Returns

Total Shareholder Return
Learning to calculate total shareholder return is easy! Simply understanding it can improve how you think of your investments and, thus, your performance. Given a long enough time horizon, that can mean a lot more money in your family's pocket. JDawnInk / Digital Vision Vectors / Getty Images

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 in which to fall, especially if you didn't grow up learning about stocks, bonds, real estate, mutual funds, or small business investments. Making it worse is the fact that Wall Street is far from blameless. Nearly every stock chart tool in existence reinforces this misconception and few have an incentive to attempt to change as it encourages higher portfolio turnover, commissions, and fees for brokerage firms.

Case in point: You are looking at a fictional enterprise, Acme Company, Inc. You pull up the stock quote and see that 10 years ago, the shares were $10 each and today, they are $20 each. Using the compound annual growth rate formula, you calculate that your money would have grown at 7.18%. The problem?  That could be completely wrong. You don't have enough information to determine what your historical return would have been because you haven't factored in other sources of wealth accumulation that you, as the owner of the business, would have enjoyed. When someone refers to "total shareholder return" in the broadest sense, that is what they mean. They want to know how much additional money they have for every $1 they invested, regardless of the source of that additional money.

How to Calculate the Total Shareholder Return Formula

  • Here is how you might calculate the total shareholder return in absolute dollars:
    (Ending Market Value of Stock - Cost Basis of Stock) + Any Dividends Received + Any Other Cash Distributions Received + The Market Value of Any Shares Received in a Spin-Off + Any Dividends Received on Shares from the Spin-Off Stock + Any Other Cash Distributions Received from the Spun-Off Stock + The Market or Liquidation Value of Any Warrants Issued
  • Here is how you might calculate the total shareholder return as a percentage:
    (Ending Market Value of Stock - Cost Basis of Stock) + Any Dividends Received + Any Other Cash Distributions Received + The Market Value of Any Shares Received in a Spin-Off + Any Dividends Received on Shares from the Spin-Off Stock + Any Other Cash Distributions Received from the Spun-Off Stock + The Market or Liquidation Value of Any Warrants Issued on any of the Stocks
    ------------------- Divided By ---------------
    Initial Cost Basis of the Stock

    The latter might become a bit more complicated because, often, when you receive a spin-off, your broker will adjust the tax cost basis on your initial investment, assigning some of that proportionally to the spin-off. If you want to use those figures, you'd need to modify the variables accordingly:

    (Ending Market Value of Stock - Adjusted Cost Basis of Stock) + Any Dividends Received + Any Other Cash Distributions Received + (Ending Market Value of Spun-Off Stock - Adjusted Cost Basis of Spun-Off Stock) + Any Dividends Received on Shares from the Spin-Off Stock + Any Other Cash Distributions Received from the Spun-Off Stock + The Market or Liquidation Value of Any Warrants Issued on any of the Stocks
    ------------------- Divided By ---------------
    Initial Cost Basis of the Stock

    In complicated cases like the Sears situation we'll cover later in the article, you might end up having to do a lot of calculations across a dozen or more companies to retroactively calculate your total shareholder return.

    The moral: Don't trust the stock chart. Investments that look like they were a failure may have actually made money. A case study I use often in my other writings is Eastman Kodak. Despite ending up in bankruptcy court, a long-term owner could have quadrupled his or her money after accounting for total return thanks to dividends and a chemical division that was spun-off into an independent business.

    I also once used a representative group of ​blue chip stocks to demonstrate how much total return could lag stock price return alone and the results frequently surprise people.

    The Total Shareholder Return Formula Used In Annual Reports Is Different

    The total shareholder return formula methodology many companies use in their annual report10-K filing, or proxy statement is fundamentally different.  What those total shareholder return charts seek to answer is the question, "How much money would an investor have made if, at 1 year, 5 years, 10 years, and 20 years in the past, he had purchased our stock, held it, and reinvested all dividends?"  A comparable total return figure is calculated for the firm's peer group (competitors, in many cases) and the S&P 500 stock market index to show the relative over/under performance.

    Here Are 5 Major Sources of Total Shareholder Return

    Historically, total shareholder return has been generated by a handful of sources:

    • Capital Gains: When you buy a stock at one price and it appreciates, the difference is known as a capital gain. For the tiny minorities of businesses 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 category. The shares of the firm traded at $8 in the 1960's and today, 50 years later, are worth more than $217,000 each.
    • Dividends: When a company generates net income, the representatives of the owners (the stockholders) in charge of hiring and firing management as well as deciding major issues, known as the board of directors, may decide to take some of that money and mail it out to, or direct deposit it in the accounts of, the stockholders so they can enjoy the fruits of their financial risk. This money is referred to as a dividend. For large, profitable enterprises, dividends have been academically shown to be the primary driver of nearly all inflation-adjusted total shareholder returns.
    • Spin-Offs: When a business decides to shed a unit or operation that no longer fits with its strategic goals, it isn't uncommon to have the subsidiary become its own publicly traded enterprise, sending owners shares as a special distribution. These stock spin-offs can be one of the most incredible sources of total shareholder return that are often completely forgotten by investors or financial journalists. Consider Sears, a once-blue chip giant that has since become a shadow of its former self that some believe is destined for bankruptcy.  The stock chart makes it appear as if it has been a never-ending, painful decline into the abyss for the past decade or two. However, Sears has spun off so many divisions, and some of those divisions, in turn, had spin-offs of their own, that an owner of Sears shares would have actually beaten the S&P 500 since the early 1990's despite the Sears stock itself showing huge losses. That's because your brokerage account would now be stuffed with ownership of one of the biggest insurance companies in the world (AllState), one of the biggest credit card processing and student loan servicing companies in the world (Discover Financial), one of the biggest investment banks in the world (Morgan Stanley), several other retailers (Orchard Supply Hardware, Sears Canada, Sears Hometown Store, and Lands' End), and, if rumors turn out to be true, there might be a real estate spin-off in the works, possibly structured as a REIT. Total shareholder return captures all of that.
    • Recapitalization or Buyout Distributions: The capitalization structure of a business is very important.  Sometimes, economic conditions change and owners can increase their wealth by modifying the existing capitalization structure, freeing up equity that had been tied up in the business.  This newly freed money, replaced by cheap debt, gets shipped out the door to owners, who can then spend, save, donate, gift, or reinvest it however they see fit.

      Within a few years of interest rates hitting a multi-century low following the Great Recession in 2008-2009, one of the largest hotel franchisors in the world, Choice Hotels International, decided to borrow a lot of money at super-cheap rates as it simultaneously paid out a one-time massive distribution.  This had the effect of modifying the debt-to-equity ratio and letting the owners extract some of their investment out of the business while still enjoying roughly the same profitability.  Instead of the usual $0.185 per share quarterly dividend, the August 24th, 2012 dividend was a staggering $10.41.

      On March 24, 2015, shares of Kraft Foods closed at $61.33. Before the stock market opened the following day, it was announced that a new business was being formed so Kraft could merge with Heinz. The shareholders of Kraft were slated to receive 49% of the new business, while the shareholders of Heinz were going to receive 51% of the new business. Concurrently, to equalize the value of the firms, the team behind the deal planned on infusing $10 billion of their own money into the business than paying a one-time $16.50 per share cash distribution to Kraft stockholders. That is real money, representing nearly 27% of the share value on the previous closing day.

      The best part about recapitalization or buyout distributions is that, sometimes, in rare cases, the executives can find a way to have it treated as a so-called "return of capital" so there is no tax on the money sent to you!
    • Warrant Distributions: Though they made a brief comeback during the credit crisis, stock warrant distributions are practically unheard of in this day and age. In olden times (think the days of legendary investors like Benjamin Graham), corporations would sometimes create warrants and distribute them to existing stockholders. These warrants behaved like stock options -- they gave the holder the right, but not obligation, to buy additional shares at a fixed price within a certain date range - but when they were exercised, the company itself would print new stock certificates and increase the total number of shares outstanding, taking the warrant premium for the corporate treasury. Speculators that wanted to hold these warrants, gambling on a rise in the stock price and knowing they would disproportionately profit if things went their way, wanted to buy these from the stockholders, many of whom would rather have cash today than the potential to buy more stock at a predetermined price.  An owner might decide to take his warrants and sell them, pocketing the cash or using it to buy even more shares of the actual common stock outright. That's another source of total shareholder return that doesn't show up on the stock chart directly.

    An Example of Total Shareholder Return for a Real Blue Chip Stock

    I once wrote a piece that examined the historical returns of PepsiCo over my lifetime. I looked at what would have happened if an investor had purchased 2,300 shares (I wanted to keep it simple by sticking to so-called round lots, which just means a block of 100 shares at a time) on the day I was born. It would have cost $102,074 to complete such a trade back in the early 1980's.

    A chart of PepsiCo's stock would make it appear that the position, following three stock splits - a 3-for-1 split on May 28th, 1986, a 3-for-1 split on September 4th, 1990, and a 2-for-1 split on May 28th, 1996 - would have turned the 2,300 shares into 41,400 shares.  That would have put the value at around $4,098,600 at the time I wrote the post.

    The problem?  That significantly understated total shareholder return because three sources of added wealth creation were excluded, having not shown up in most stock charts.

    1. Over the past 32+ years, PepsiCo would have paid you $1,058,184 in cumulative cash dividends.
    2. On October 6th, 1998, PepsiCo divested its restaurant division, which owned franchises such as KFC, Taco Bell, and Pizza Hut, by spinning off a business called Tricon Global Restaurants. The investor would have received an initial block of 4,410 shares that were split 2-for-1 on June 18th, 2002, and again, 2-for-1 on June 27th, 2007.  That would have resulted in holding 16,560 shares of Yum! Brands (the business changed its name), which had a current market value of another $1,354,608.
    3. On top of this, Yum! Brands paid out cumulative 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 total return is what really matters, nothing will.