Ratios: Economic Return from Investing - Video Tutorials & Practice Problems
On a tight schedule?
Get a 10 bullets summary of the topic
1
concept
Ratios: Economic Return from Investing
Video duration:
3m
Play a video:
now, let's discuss a useful ratio for investors, the economic return of investing. So the economic return of investing from investing, it's a ratio used by investors to analyze their profits. Okay, to see how much they're actually making from their investments. So we're not gonna actually use financial statements directly here, because we're kind of looking from the investor's perspective in this case. Okay, So we're gonna look at what did the investor get in dividends and capital appreciation, and how much did they invest into the stock. Okay, So, um, well, actually, a company could use these to write if a company is buying short term investments, something like that. Well, they would be the investor in this case, but for the most part we're thinking, we're from the investor's perspective here. So let's check out the economic return from investing. So in the numerator, we've got dividends and interest received. Right? That's the first thing. And to that, we're gonna add the change in fair value of the investment. Okay, So the dividend and interest received. Notice below, below the green box that have the economic return comes from two sources, right? The first one is the dividends received. So the first source is the dividends received, and this is called the dividend yield, right? How much dividends we're getting from our investment. And the other way we make money as investors, we get dividends, right? That's just cash we received from our investment, but we also can gain from the capital appreciation, right? The capital gains and losses. So this is when the fair value of the investment changes. Let's say you bought a share of stock for $20 And then it went up to $30 by the end of the year. Well that change in the value of the stock. Well that that's money you essentially earned right. If you sold the stock right now, you would have been up those $10. The change from the 20 up to the 30, that would have been a gain of $10 there. You can also lose money, right? If you bought it for 20 and it went down by five and it's down to 15. Well, that's a capital loss in that case. So notice what we've got in our numerator, we have those dividends and interest received right? That that deals with our dividend yield dividends. That's more if we're dealing with stock and interest, that's if we had bought a bond or something like that. And then we also have the change in fair value. So that's that capital appreciation, the gains or losses from the change in the value of the investment. So that's everything that's like all the profit we can get right, we either get it from dividends or we get it from the change in fair value. That's where we're gonna get our profit and we're gonna divide that by the original cost of the of the investment. And we're gonna say it's the fair value at the beginning of the period because when we're dealing with investments, we're generally going to be changing the fair value. So at the beginning of the period it's going to be where we started from and then we'll see what's happened during the period. Okay, so the fair value at the beginning of the period and they're generally just going to have to give you that information. So this ratio we usually showed as a percentage. So you're just gonna have to multiply by 100. Move that decimal two places over to get into percentage mode. Right? So notice in the numerator, like we said, it's showing all the profits that we can get and the denominator is showing the value at the beginning of the period. So how much did we get based on what we started with? Okay, so Again, it's showing the amount of profit or loss, but this is per dollar invested. Once we get our actual percentage, what if it says 5%? That means for each dollar we invested what we're getting a nickel in in uh profit. Right? So that's about it. For the economic return from investing. Let's go ahead and jump into some practice problems and calculate this ratio
2
Problem
Problem
An investor bought a share of Apple common stock for a cost of $160. During the year, Apple paid dividends of $1 per share. At the end of the year, the stock price had increased to $177. Calculate the economic return from investing.
