What Is Capital Gains Yield?
A capital gains yield is the rise in the price of a security, such as common stock. For common stock holdings, the CGY 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
Capital Gains Yield
Understanding Capital Gains Yield
For example, Peter buys a share of company ABC for $200 and then sells the share for $220. The CGY for the share in company ABC equals (220-200) / 200 = 10%.
Investors must evaluate the total return yield and CGY of an investment. A CGY evaluation does not include dividends; however, 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 CGY and dividend 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, and 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 CGY 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 indicating higher stock performance. In addition, the calculation of CGY is related to the Gordon growth model. For constant growth stocks, the CGY 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 security cannot generate CGY 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 paid out as a dividend is a dollar the company cannot reinvest into the company.
Other stocks pay lower dividends but may produce higher capital gains. These are growth stocks because profits flow back into the company for growth instead of the company distributing them to shareholders while other stocks pay poor dividends and produce low or no capital gains.
Many investors calculate a security's CGY because the formula shows how much the price fluctuates. This helps an investor to decide which securities are a good investment. Capital gains may result in paying capital gains taxes. However, investors can offset the taxes by losses or carry it over into the following year.