What is a 'Capital Gains Yield'
A capital gains yield is the rise in the price of a security, such as a common stock. For common stock holdings, the capital gains yield is the rise in the stock price divided by the original price of the security.
P0 = Original purchase price of the security
P1 = Current market price of the security
BREAKING DOWN 'Capital Gains Yield'For example, Peter buys a share of company ABC for $200 and then sells the share for $220. The capital gains yield (CGY) for the share in company ABC equals (220-200) / 200 = 10%.
Investors must evaluate the total return yield and capital gains yield of an investment. Dividends are left out of a capital gains yield valuation, but depending on the stock, dividends may include a considerable part of the total return in comparison to capital gains.
The total return on a share of common stock includes capital gains yield and dividend yield. Capital gains yield (CGY) equals the total return if the investment generates no cash flow. It is the amount of money a stock price is forecast to appreciate or depreciate. It is the percentage change in the market price of a security over time. However, if a stock decreases in value, it is a capital loss.
The capital gains yield formula employs the rate of change formula. CGY can be positive, negative or a capital loss. However, an investment that has a negative CGY may generate profits for an investor.
The higher the share price at a specific period, the greater the capital gains and this signifies higher stock performance. In addition, the calculation of capital gains yield is related to the Gordon growth model. For constant growth stocks, the capital gains yield is g, the constant growth rate.
CGY is unpredictable and may occur monthly, quarterly or annually. This format differs from dividends that are set by the company and paid out to shareholders at a predefined period.
A capital gains yield cannot be generated if the share price falls below the original purchase price. Some stocks pay high dividends and may produce lower capital gains. This occurs because every dollar that is paid out as a dividend is a dollar that the company cannot reinvest back into the company.
Other stocks pay lower dividends but may produce higher capital gains. These stocks are considered growth stocks because profits are redirected back into the company growth and not distributed to shareholders, while other stocks pay poor dividends and produce a low or no capital gains.
Many investors choose to calculate the CGY of a security because the formula usually provides an indication of how much the price fluctuates. This helps an investor decide which securities are good investment choices. Capital gains may result in paying capital gains taxes. However, the taxes can be offset by losses or carried over into the following year.