Capital gains yield is computed by dividing next year’s annual dividend by the current stock price.
Select one:
True
False
The correct answer and explanation is :
False
Capital gains yield is not computed by dividing next year’s annual dividend by the current stock price. Instead, the capital gains yield refers to the rate of return on the investment that comes from changes in the stock’s price (capital appreciation or depreciation) rather than dividends.
Here’s a breakdown of why the statement is false and a clarification of how capital gains yield is computed:
Capital Gains Yield:
Capital gains yield is the percentage change in the price of a stock from one period to the next, typically a year. It reflects the appreciation (or depreciation) in the stock’s price. It is calculated by the formula:
$$
\text{Capital Gains Yield} = \frac{\text{Price at the End of the Period} – \text{Price at the Beginning of the Period}}{\text{Price at the Beginning of the Period}}
$$
This formula measures the change in stock price, excluding any dividends paid. The capital gains yield is purely a measure of price movement.
Dividends and Dividend Yield:
Dividends are separate from capital gains yield. The dividend yield is the annual dividend payment expressed as a percentage of the current stock price, calculated as:
$$
\text{Dividend Yield} = \frac{\text{Annual Dividend}}{\text{Current Stock Price}}
$$
The statement in the question mistakenly mixes the concept of dividend yield with capital gains yield. While dividends can contribute to the overall return on an investment in stocks, they are distinct from capital gains yield.
Total Return:
The total return from a stock investment is the combination of both the capital gains yield and the dividend yield. In other words:
$$
\text{Total Return} = \text{Capital Gains Yield} + \text{Dividend Yield}
$$
So, while dividends can add to the overall return, they are not used to compute capital gains yield, which specifically focuses on changes in the stock’s price.
In conclusion, the correct definition of capital gains yield involves price appreciation, not the next year’s dividend.