How To Calculate The Expected Total Return of Any Stock
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In this presentation, we demonstrate - using an actionable example of Coca-Cola (KO) - how to calculate the expected total return of any stock. The expected total return calculations demonstrated in this presentation are based on business growth, valuation changes, and dividend yield.
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How To Calculate The Expected Total Return of Any Stock
- 1. How To Calculate The Expected Total Return of Any Stock With Nick McCullum from Sure Dividend
- 2. What is Expected Total Return? Expected total return is the complete return that investors receive. It is composed of: -Dividend payments -Changes in stock price
- 3. How To Calculate Expected Total Return 1. Find the initial cost of the investment 2. Find total amount of dividends or interest paid during investment period 3. Find the closing sales price of the investment 4. Add sum of dividends and/or interest to the closing price 5. Divide this number by the initial investment cost and subtract 1
- 4. How To Calculate Expected Total Return 1. Initial cost: $10 2. Total interest/dividends paid: $1 3. Sale price of the investment: $20 4. Sum of sale price and interest/dividends: $20 + $1 = $21 5. Dividend this number by the initial investment and subtract 1: $21 / $10 – 1 = 110%
- 5. How To Calculate Expected Total Return This tutorial shows how to calculate total return when all the variables are known. In reality, total return calculations have much more uncertainty. Forward-looking total return estimates can be computed using three factors: 1. Dividend yield 2. Expected earnings growth 3. Expected valuation multiple change
- 7. Coca-Cola Example: Expected Total Return Calculation 1. Dividend yield: 3.1% 2. Expected earnings growth 3. Expected valuation multiple change
- 8. Step 2: Determine a Reasonable Earnings Estimate Earnings estimates can be either internally generated (created by you) or externally found (provided by analysts). If you are uncomfortable estimating future earnings growth yourself, it’s best to rely on analysts. Your stock broker likely provides earnings estimates from a number of analysts in its research dashboard.
- 9. Step 2: Determine a Reasonable Earnings Estimate This is an example of such an earnings estimate table. Analysts expect Coca-Cola’s earnings to grow from $2.08 in 2013 to $2.38 in 2020, representing annual growth of 1.9% per year. It’s best to use a long time frame whenever possible.
- 10. Coca-Cola Example: Expected Total Return Calculation 1. Dividend yield: 3.1% 2. Expected earnings growth: 1.9% 3. Expected valuation multiple change
- 11. Step 3: Determine a “Fair” Valuation Multiple and Compute How This Will Impact Future Returns Nobody knows for sure what a business is “really” worth. With that said, businesses are valued based on what “multiples” they trade at. These valuation metrics are multiples of financial metrics like earnings, book value, or free cash flow. Companies tend to revert to their long-term average valuation multiples over time.
- 12. Step 3: Determine a “Fair” Valuation Multiple and Compute How This Will Impact Future Returns To see how valuation will impact future returns, compare a company’s current valuation multiple against its long-term average. Finding historical valuation data can be hard. Our favorite resource is Value Line, which is expensive but often available for free at your public library.
- 14. Step 3: Determine a “Fair” Valuation Multiple and Compute How This Will Impact Future Returns 15-year average P/E: 20.9 Current P/E: 25.5
- 15. Step 3: Determine a “Fair” Valuation Multiple and Compute How This Will Impact Future Returns If we assume that Coca-Cola’s price-to-earnings ratio will revert to the mean over a 5-year period of time, we can calculate its impact on future returns with the following math:
- 16. Step 3: Determine a “Fair” Valuation Multiple and Compute How This Will Impact Future Returns If we assume that Coca-Cola’s price-to-earnings ratio will revert to the mean over a 5-year period of time, we can calculate its impact on future returns with the following math: 20.9
- 17. Step 3: Determine a “Fair” Valuation Multiple and Compute How This Will Impact Future Returns If we assume that Coca-Cola’s price-to-earnings ratio will revert to the mean over a 5-year period of time, we can calculate its impact on future returns with the following math: 20.9 25.5
- 18. Step 3: Determine a “Fair” Valuation Multiple and Compute How This Will Impact Future Returns If we assume that Coca-Cola’s price-to-earnings ratio will revert to the mean over a 5-year period of time, we can calculate its impact on future returns with the following math: ( 20.9 25.5 )( 1 5)
- 19. Step 3: Determine a “Fair” Valuation Multiple and Compute How This Will Impact Future Returns If we assume that Coca-Cola’s price-to-earnings ratio will revert to the mean over a 5-year period of time, we can calculate its impact on future returns with the following math: ( 20.9 25.5 )( 1 5) −1
- 20. Step 3: Determine a “Fair” Valuation Multiple and Compute How This Will Impact Future Returns If we assume that Coca-Cola’s price-to-earnings ratio will revert to the mean over a 5-year period of time, we can calculate its impact on future returns with the following math: ( 20.9 25.5 )( 1 5) −1 = −3.9% You can change the mean reversion period if you’d like. The shorter the period, the greater the impact it has on your expected total return calculations
- 21. Putting It All Together 1. Dividend yield: 3.1% 2. Expected earnings growth: 1.9% 3. Expected valuation multiple change: -3.9% Expected Total Return = 3.1% + 1.9% - 3.9% = 1.1%
- 22. Thanks For Watching! Three homework items: 1. Perform you own expected total return calculations and email them to me at nick@suredividend.com 2. Like this video and leave a comment 3. Subscribe to our channel (Sure Dividend) if you want to learn more about investing in high-quality dividend growth stocks