What Is Capital Gains Yield (CGY)?
A capital gains yield is the rise in the price of a security, like common stock, over a given period of time. It does not include any dividends and the yield is based only on stock price appreciation (or depreciation).
The capitals gain yield can provide useful information to the company shareholders because it shows whether they would get a return on the stock price if it grows over time.
The capital gains yield formula shows investors how much the price of the stock fluctuates and helps them to decide whether or not the security is a wise investment.
So, if a stock had a lot of price fluctuation, this could indicate that the security is high risks. It means the investor could achieve above-average returns, but there is a risk that it could go the other way if the price falls.
Capital gains yield is the percentage price appreciation on an investment. It is calculated as the increase in the price of an investment, divided by its original acquisition cost. For example, if a security is purchased for $100 and later sold for $125, the capital gains yield is 25%. If the price of an investment falls below its purchase price, there is no capital gains yield.
This concept does not include any dividends received; it is only based on changes in the price of an investment. To calculate the total return on a share, an investor must combine the capital gains yield and the dividend yield.
Capital Gains Yield Formula
Capital gains yield is a simple formula to calculate as the only components needed are as follows:
- The original price of the security
- The current price of the security
CGY = (Current Price – Original Price) ÷ Original Price x 100
The capital gains yield formula works out the rise in the price of the security and divides it by the original purchase price.
This is known as a rate of change formula and CGY, depending on the original and current purchase prices, can be a positive, negative or capital loss.
It’s easy to see then that the higher the current share price at a specific period, the higher the performance of the stock, which means more capital gains yield.
The CGY calculation is related to the Gordon growth model – which is used to determine the value of stock-based on a series of perpetuity payments that grow at a constant rate.
In that model, the CGY is the variable g, the constant growth rate.
Capital Gains Yield Analysis
The capital gains yield is unpredictable because of price fluctuations, and it can in monthly, quarterly, or annual intervals. This is different from dividends because those are set by the company and shareholders receive the payments at predefined times.
If the current share price falls lower than the original purchase price, the security can’t guarantee a capital gains yield.
You might find that some stocks will pay out a high dividend and produce lower CGY. The reason for this is that when the money is paid out as a dividend it can’t be reinvested into the company (which could increase the share price).
On the flip side, stocks can also pay low dividends and produce a higher capital gains yield. These are known as growth stocks because the company is reinvesting to continue growing rather than distributing the profits to shareholders.
An example of a company which pays out little, or no dividends so that they can invest for growth is Amazon. This reinvestment helped Amazon stock to generate returns of nearly 40% per year over the last decade.
As I mentioned earlier, a lot of investors like to calculate the capital gains yield because it shows price fluctuation. It’s a useful tool for helping them decide whether the security is a good investment.
It’s also worth noting here that capital gains can result in the investor paying capital gains taxes. Of course, you can offset the taxes by losses or carry them over into the following tax year.
The Benefits of Calculating Capital Gains Yield
By calculating capital gains yield, you can:
- Understand the amount of tax you have to pay on your investment. In general, the tax rates for capital gains and dividend returns are usually different. Capital gains normally pose a higher tax rate than dividend returns. Hence, it is important to understand how to calculate capital gains yield on the stock so you know the amount of tax you have to pay on your investment.
- Understand the components of your investment returns. Calculating the capital gains yield also helps you to understand where your returns come from. Dividend returns are normally more valued by most investors due to their stability and lower tax rate. By having a better understanding of the your investments’ returns, you will be able to adjust your portfolio accordingly.
- Understand the volatility of your investment. The volatility of your investment can also be inferred by calculating and understanding the capital gains yield. If the capital gains yield of your investment fluctuates a lot in a short period of time, it might be due to the high volatility of your investment.
All in all, capital gains yield tax is a very handy tool when it comes to analyzing the returns of your investments. However, it is also to keep in mind that dividend returns can also contribute majorly to your return. Thus, it is important to take them into account as well.
When working with capital gains yield, the below points are worth bearing in mind as a quick recap of what it is, why it’s used, and how to use it:
- CGY is the rise or decrease in the price of a security (such as stock) over a given time period
- It only applies to stock price appreciation, and not to dividends
- It’s useful for investors to show the price fluctuation of a stock
- Capital gains yield can be positive, negative, or capital loss
- The CGY value is used as the variable g, constant growth rate, in the Gordon growth model calculations
- Capital gains yield paid in unpredictable intervals, unlike dividends which have predefined payment times
- Some stock can pay a high dividend and low CGY, some pay a low (or no) dividend and a higher capital gain.
- Investors may need to pay capital gains tax, although it can sometimes be offset or carried over to the following period.