Evaluating the rate of return

COMPANIES are bombarding shareholders with a constant stream of information claiming to be measures of performance. The nature of these measures range from accounting-based profit announcements to share price move-ments, dividend yield to earnings per share figures. What shareholders need is a measure that actually tells them whether their investment has paid off and provided an acceptable rate of return.

Total Shareholder Return (TSR) analysis takes the approach of looking at the aggregate return an investor would have received from a company over a given holding period. It captures all forms of return, including capital value growth, dividend payments, capital structure changes and taxation benefits from imputation. The TSR analysis can be calculated as a percentage return over the holding period, or as the change in the value of a given investment, say $100, over the time the investment is held. The analysis can be done for any holding period with one, three and five-year time periods, typically used to reflect short, medium and long-term performance.

Obviously the analysis makes the assumption of a rational and professional investor who reinvests dividends into the stock, participates in share structure changes and maximises the tax advantages available.

Evaluation criteria

TSR analysis assumes that all interim earnings, such as dividend payments, are reinvested in the company and are subject to the same investment performance as the original shareholding.

Changes in the underlying share structure of a company can affect the observed share price. These changes include share splits, bonus issues and rights issues.

This effect is taken into account by applying a dilution factor.

The holding period relates to the length of the investment period with the TSR analysis, in effect, looking back retrospectively for one, three or five-year periods. For the purposes of this analysis, the ending position is June 30 2001.

Value of $100

The performance profile of specific companies can be tracked over time by examining the value of $100 invested in the business. The value of $100 is used due to its simplicity and is the initial value of the portfolio.

The value of that initial investment is tracked over the holding period, be it one, two, three, four or five years.

During this period, changes in share prices, dividend payments and capital restructuring will affect the value of the investment.

Hence, the value of the initial $100 will fluctuate and indicates to the shareholder, in simple terms, whether he/she has made a return on the $100. A value above $100 will indicate that he/she is “in the money”, while a figure less than $100 will indicate that he/she has sustained losses in the value of the shares.

In the table (right), Company A has generated positive returns for the shareholder over the holding period. Conversely, Company B has destroyed value for its shareholders.

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