Return

Return:

A return, also known as a financial return, in its simplest terms, is the money made or lost on an investment over some period of time.

A return can be expressed nominally as the change in dollar value of an investment over time. A return can also be expressed as a percentage derived from the ratio of profit to investment. Returns can also be presented as net results (after fees, taxes, and inflation) or gross returns that do not account for anything but the price change. 

Key Points:

1. A return is the change in price of an asset, investment, or project over time, which may be represented in terms of price change or percentage change.
2. A positive return represents a profit while a negative return marks a loss.
3. Returns are often annualized for comparison purposes, while a holding period return calculates the gain or loss during the entire period an investment was held.
4. The real return accounts for the effects of inflation and other external factors, while the nominal return is only interested in price change.
5. The total return for stocks includes price change as well as dividend and interest payments.
6. Several return ratios exist for use in fundamental analysis.

THE TWO COMPONENTS OF ASSET RETURNS:

 Return on a typical investment consists of two components:  

• Yield: 

The basic component many investors think of when discussing investing returns is the periodic cash flows (or income) on the investment, either interest (from bonds) or dividends (from stocks). The distinguishing feature of these payments is that the issuer makes the payments in cash to the holder of the asset. Yield measures a security’s cash flows relative to some price, such as the purchase price or the current market price. 

• Capital gain (loss): 

The second component is the appreciation (or depreciation) in the price of the asset, commonly called the capital gain (loss). We will refer to it simply as the price change. In the case of an asset purchased (long position), it is the difference between the purchase price and the price at which the asset can be, or is, sold; for an asset sold first and then bought back (short position), it is the difference between the sale price and the subsequent price at which the short position is closed out. In either case, a gain or a loss can occur. 

(This component involves only the difference between the beginning price and the ending price in the transaction. An investor can purchase or short an asset and close out the position one day, one hour, or one minute later for a capital gain or loss. Furthermore, gains can be realized or unrealized.)

Putting the Two Components Together

Add these two components together to form the total return:

 Total return = Yield + Price change      (Equation 1)

where the yield component can be 0 or +

                the price change component can be 0, + , or -

Example:

A bond purchased at par ($1,000) and held to maturity provides a yield in the form of a stream of cash flows or interest payments, but no price change. A bond purchased for $800 and held to maturity provides both a yield (the interest payments) and a price change, in this case a gain. The purchase of a non dividend-paying stock, such as Apple, that is sold 6 months later produces either a capital gain or a capital loss but no income. A dividend-paying stock, such as Microsoft, produces both a yield component and a price change component (a realized or unrealized capital gain or loss).

Equation 1 is a conceptual statement for the total return for any security. Investors’ returns from financial assets come only from these two components—an income component (the yield) and/or a price change component, regardless of the asset. Investors sometimes mistakenly focus only on the yield component of their investments, rather than the total return, and mistakenly assume they are achieving acceptable performance when they are not.