What Is a Dividend-Adjusted Return?
A dividend-adjusted return is a calculation of a stock's return that relies not only on capital appreciation but also on the dividends that shareholders receive. This adjustment provides investors with a more accurate evaluation of the return of an income-producing security over a specified holding period.
- A dividend-adjusted return takes into consideration both the appreciation of a stock's price as well as its dividends to arrive at a more accurate valuation of a stock's return.
- When calculating the dividend-adjusted return, an investor can add the total amount of dividends received to the price at which they sold the stock.
- The dividend-adjusted return is a component of total return, which takes into consideration all income streams of an investment.
- Dividends also reduce the share price of a stock, which is adjusted after closing on the ex-dividend date, as dividends are seen as a devaluing of a company.
- Dividend investing is a type of investment strategy and can be good for risk-averse investors.
- The capital gains tax and dividend tax will need to be taken into consideration to arrive at the true profit of an investment.
Understanding a Dividend-Adjusted Return
When investors purchase stocks they expect that the stock price will increase based on their evaluation of the company, and at some point, they can sell the stock for a profit. The price at which they sold it compared to what they paid for it will be the return on their investment.
This, however, may not actually be the total return on their investment. If the stock also paid out dividends during the tenure in which they held the stock, then this will need to be added in the return calculation, which is the dividend-adjusted return, which will provide the total return on their investment.
For example, an investor may begin calculating a simple return by taking the difference in market price and purchase price and dividing this by the purchase price. Say an investor purchased a share of Amazon (AMZN) on Jan. 1, 2018, for $1,172 and sold it on July 11, 2018, for $1,755. The simple return would be ($1,755 - $1,172) / 1,172 = 49.74%.
While Amazon does not presently pay dividends, if it did issue a $0.50/share quarterly dividend, and the investor received two distributions during the six months they held the stock, they could adjust their return by adding these to the sale price. Their dividend-adjusted return would be ($1,756 - $1,172) / 1,172 = 49.83%.
The dividend-adjusted return is a component of total return, which takes into account both the changes in market value and any other streams of income, such as interest, distributions, and dividends expressed as a percentage (i.e., divided by the share price).
Man investors choose their stocks based on the dividend payout, known as a dividend investment strategy. This type of strategy can be good for risk-averse investors, such as investors that are further along in their investment career and close to retirement. These types of investors are not necessarily looking for price appreciation but rather a steady source of income from their investments.
Dividends and the Adjusted Closing Price
The dividend-adjusted close, or adjusted closing price, is another useful data point that takes into account any distributions or corporate actions that occurred between the previous day’s closing price and the next day’s opening price. It reflects the true closing price of a stock.
For example, a company’s stock price closes at $60 and they announce a dividend of $1. The share price is $60 on the ex-dividend date and is then reduced by $1, the dividend amount, to $59, which is the adjusted closing price due to the dividend payout.
Dividends lower the value of a stock because profits are distributed to shareholders rather than being invested back into the company, which is believed to be a devaluing of the company and this devaluing is taken into consideration by the reduction in the share price.
Dividend-Adjusted Return and Taxes
When calculating a return on investment, whether that be purely capital appreciation or a dividend-adjusted return, an important component is to determine the value after taxes. Investors have to pay a capital gains tax on any appreciation in the value of a stock from the time they buy to the time they sell.
The current long-term capital gains tax is 0%, 15%, or 20%, depending on your tax bracket and marital status. The tax rate for qualified dividends is the same as the long-term capital gains tax and for non-qualified dividends, it is the same as the federal income tax for your tax bracket.