What is Capital Gains Yield (CGY)?
What Is Capital Gains Yield (CGY)? 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.
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.
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
That said, the concept doesn’t including any income received from the investment.
A capital gains yield is the rise in the price of an investment such as a stock or bond, calculated as the rise in the security’s price divided by the original price of the security.
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.
An investment cannot generate CGY if the share price falls below the original purchase price.
Capital gains yield is calculated the same way for a bond as it is for a stock: the increase in the price of the bond divided by the original price of the bond.
Capital Gains Yield Formula
We use this formula when we want to know how much return we will get only based on the appreciation or depreciation of stock.
Capital Gains Yield Formula = (P1 – P0) / P0
P0 = Initial Stock Price
P1 = Stock Price after First time period.
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.
Interpreting Capital Gains Yield
It is difficult to say much about an investment from its Capital Gains Yield alone. We have seen how it is possible for the Total Gain from an investment to be larger than the Capital Gain. However, we have not commented on the size of this difference.
Let us analyze an extension of the previous example. Unlike John, who invested in company XYZ, Mark invested in company ABC, which had a market price of $100 per share at the start of the year. At the end of the year, company ABC has a market price of $105 per share. In addition, company ABC issues a dividend of $50 per share.
The Capital Gains Yield for Mark’s investment is (105-100)/100 = 5%, which is much less than the 50% that John receives.
However, Mark’s dividend gain yield is 50/100 = 50%, which is greater than what John receives.
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.
An investment 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.
Dividend yield and Capital gains yields are required in case of appreciation of a stock price. A growing business in most of the cases gives a scope of capital appreciation for the shareholders. Yields refer to the profits generated after selling a particular stock at a premium price over a period of time-based on the invested amount and is measured by the excess cash flow received by the investor after investing on security.
In most of the cases, a yield is computed on yearly basis and in extreme cases yields are calculated on a half-yearly and quarterly basis.