Understanding stock returns — measures, taxes, and strategy
Measuring stock returns accurately is crucial for investors who want to evaluate performance, compare investments and make informed decisions. There are several ways to express returns: absolute return, percentage return, Compound Annual Growth Rate (CAGR), and total return (which includes dividends). Each metric answers a different question. Absolute return tells you how much money you made; CAGR shows the annualized growth rate; total return captures both capital gains and income from dividends.
Absolute return and percentage return
Absolute return (in currency terms) is simply the difference between the sale proceeds and the initial investment. Percentage return divides that gain by the initial investment to give a normalized measure useful for comparison. For example, buying 100 shares at ₹100 and selling at ₹150 results in a capital gain of ₹5,000 (100 × (150−100)) which is 50% on the invested capital of ₹10,000.
Compound Annual Growth Rate (CAGR)
CAGR is the annualized rate that converts the start value into the end value over the holding period, assuming compounding. It’s calculated as:
CAGR = (Ending value / Beginning value)^(1 / years) − 1
CAGR is especially useful when comparing investments held for different lengths of time.
Total return (including dividends)
Total return adds dividends and other payouts to capital gains. If you received dividends during the holding period, include them in the numerator. For accuracy, add reinvested dividends' effect — reinvested dividends buy more shares and compound over time. When dividends are small relative to price changes, a simple sum is often sufficient for quick estimates.
Tax considerations
Capital gains tax treatment depends on holding period and local rules. Short-term gains are often taxed at higher rates than long-term gains. Dividend income may be taxed differently (some jurisdictions tax dividends at source, others treat them as ordinary income). Always factor after-tax returns when comparing investments, especially when tax rates differ between income and capital gains.
Practical tips for investors
Use CAGR to compare returns across assets and timeframes.
Include dividends for total return — it matters over long horizons.
Reinvest dividends when possible to accelerate compounding.
Consider transaction costs and taxes — they reduce net returns.
Beware of survivorship bias when using historical indices or funds for comparison.
Examples and scenarios
Example: Purchased 50 shares at ₹200, sold after 4 years at ₹350, received ₹10 per share in dividends. Absolute gain = 50 × (350−200) = ₹7,500; dividends = 50 × 10 = ₹500; total gain = ₹8,000. CAGR on capital gain only can be computed using the formula above with beginning value ₹10,000 and ending value ₹17,500.
Limitations and nuances
Simple calculators assume no reinvestment timing complexity or partial sells. Real portfolios may have multiple purchases and sales; use XIRR or portfolio-level metrics to compute precise returns across irregular cash flows.
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