Two components, one total

What a shareholder actually earns

A shareholder is paid in two ways, and only one of them passes through the company’s books. Dividends are cash the company chooses to distribute. Capital gain is the rise in the share price between purchase and sale — money that comes from the next investor, not from the company. Together they make up the shareholder’s total return, and the midterm asks you to split it.

Worked example

An investor buys one Prairie Sky share at $20.00 on 2 January. During the year the company pays $0.60 of dividends per share. On 31 December the investor sells the share for $23.00.

Both components are measured against the opening price — the money the investor actually put at risk:

$$\text{Dividend yield}=\frac{0.60}{20.00}=3.00\%$$

$$\text{Capital gain}=\frac{23.00-20.00}{20.00}=15.00\%$$

$$\text{Total return}=3.00\%+15.00\%=18.00\%$$

The same figure can be reached in one line: $(0.60+23.00-20.00)÷20.00=3.60÷20.00=18\%$. The decomposition matters because the two parts answer different questions. The yield tells you what the company chose to pay out; the gain tells you what the market decided the company became worth.

When the price falls

Suppose instead the share was bought at $30.00,paid$0.90 of dividends, and was sold at $27.00. The yield is $0.90 \div 30.00 = 3.00\%$, the capital gain is $(27.00 - 30.00) \div 30.00 = -10.00\%$, and the total return is $-7.00\%$. A positive dividend does not rescue a falling price; it only softens it. Notice that both examples have a 3 % yield — the yield alone says almost nothing about how the investor did.

Two traps

Use the opening price, not the closing price. Dividing the $0.60 dividend by the $23.00 closing price gives 2.61 %, which describes the yield a new buyer would receive at today’s price — a different question from what the investor who bought at $20.00 earned.

A share dividend is not income. If Prairie Sky pays a dividend in shares rather than cash, the holder owns more shares of a company that has given away nothing; each share is worth proportionately less. Only a cash dividend is a return in the sense used here (share dividends are recorded in lesson 4.5).