Investors place their bets in the stock market to make money, whether by an increase in a stock’s market price or through the receipt of stock dividends. It’s difficult, however, to determine the degree to which a certain investment contributes to your wealth by simply viewing the stock’s market price both when you bought the asset and when you sold it.
A more practical approach is to gauge a stock’s performance in dollars and cents using the realized annual return (RAR) metric, which considers multiple factors, such as the fluctuations in a stock’s market price and the stock dividends that are paid to investors.
Read More: Cumulative Return vs. Annualized Return
Calculate Stock’s Realized Annual Return
The realized annual return is a straightforward metric you can use to calculate the amount of cash you earned or lost by buying and holding a stock for one year. The RAR equals the stock’s market price at the end of one year plus the dividends you received minus the stock’s price at the beginning of the year.
For instance, assume that one year ago you purchased one share of ABC Company’s common stock for $20. Next, assume the stock’s appreciation during that year was $3, so the share’s market price is now $23. Also, assume you received a 50 cent dividend.
Based on that information, you calculate the stock’s realized annual return: Add $20 to $3 for a sum of $23. Then, subtract $20 from $23 plus 50 cents, or $23.50, which equals $3.50. Your RAR is $3.50 per share.
Benefit of RAR
You calculate the realized annual return to determine the contribution of a certain investment to the annual increase in your wealth. The equation contributes nothing, however, to your knowledge of the relative value of one stock versus another when value is measured in terms of a stock’s growth relative to its purchase price.
For instance, a $4 appreciation for stock that was purchased for a market price of $6 a share, represents a growth rate of about 66 percent. But a $4 appreciation in a stock you purchased for $400 per share represents a growth rate of 1 percent.
Compare Stock Performance
To compare the performance of stocks of different types, such as a growth and dividend stock, use the realized annual return calculation. You do so, by comparing the performance of the two stocks for a year.
For instance, assume a growth stock you purchased on January 1 for $10 has a year-end price of $20 and that the stock’s shareholders received a 20 cent dividend. This stock’s realized annual rate of return is equal to
((($20 +20 cents) -$10) / $10) x 100) = 102 percent RAR
Next, assume a dividend stock you purchased on January 1 for $300 has a year-end price of $350 and the dividend paid is $12. This stock’s realized annual rate of return equals 20.6 percent:
(($350 + $12) - $300)/$300) x 100) = 20.7 percent
Actual Performance vs. Projected Earnings
Whereas realized annual return is a measure of a stock’s past performance, projected earnings or expected returns is an average of a stock’s projected returns over a certain period. The latter is determined by totaling the rates of return for that period and dividing that sum by the number of returns included in that total.
A practical way is to gauge a stock’s financial performance is to use the RAR metric. Realized annual return considers multiple factors, such as the fluctuations in a stock’s market price and the stock dividends that were paid to investors. Alternatively, an investor might use an asset's annual or annualized return, which is a measure of the average amount that an investment has increased during a year.
Billie Nordmeyer is an IT consultant of 25 years standing. As a senior technical consultant for SAP America and Deloitte Touche DRT Systems, a business analyst, senior staff, and independent consultant, Billie has worked across the retail, oil and gas, pharmaceutical, aeronautics and banking industries. Billie holds a BSBA accounting, MBA finance, MA international management as well as the Business Analyst and Software Project Management certificates from the Cockrell School of Engineering at the University of Texas at Austin.