Total Shareholder Return: Explained!

Total Shareholder Return: Explained!

Discover how companies generate returns for you and uncover the driving forces behind your investment success!

Have you ever found yourself eagerly checking your portfolio’s stock every day, hoping for that upward tick? Well, we have all been there. 

But wait, have you ever wondered if there is any way to measure the success rate of your investment as a shareholder? Well, there is a measure, and it is called the Total Shareholder Return (TSR).

It is a robust measure that unveils the true returns of equity investors.

Today we will decode the calculation of TSR, explore its significance, understand its drivers, and equip you with the tools to make informed investment decisions. 

Let’s begin. 

What is Total Shareholder Return?

The total shareholder return is the rate of return an investor earns after buying a company’s stock during a said investment period. We know that when we buy a company’s stock, we make money in two ways – capital appreciation and dividend yield and by adding these two, we get TSR. 

Total shareholder return is an essential measure because it helps to compare the performance of stock returns of different companies. 

Why is it necessary to look at total shareholder return when an investor can easily check the change in share price over a period of time for different time frames? 

The reason is that a few companies may have high share appreciation and low dividend yield and vice versa. Hence, instead of looking at several components, you can compare TSR with its competitors. 

Calculation of Total Shareholder Return

If you want to calculate the total shareholder return for one year, all you have to do is add the change in share price over the year and the total dividend the company has distributed in one year. Then divide this by the share price at the beginning of the year. 

Let’s understand this with an example. Let’s look at Coal India in a one-year time frame. On 31st May 2022, Coal India was trading at Rs 192; on 31st May 2023, it was trading at Rs 241. So, if you had purchased one share of the company, you would have made Rs 49 in capital appreciation. During this time frame, the company has declared two interim dividends of Rs 15 and Rs 5.25 per share. 

So, the total shareholder return for Coal India is (Rs 49 + Rs 20.25) / Rs 192, which comes to 36.8%. 

Similarly, you can calculate the TSR for every stock. 

What Are the Drivers of Total Shareholder Return?

Net Income Growth

Revenue is the soul of a company. When a company generates higher revenues, investors gain confidence in the company. Every company uses different strategies to generate higher revenue based on the industry it caters to. For example, a pharmaceutical company invests in research and development and focuses on new product innovation to generate revenue. 

Similarly, the financial services sector can generate higher revenues by stepping into new markets, technological advancements, and developing innovative financial products.

If the net income grows year on year, shareholders’ earnings would also increase, leading to an increase in share price. 

Earnings Per Share (EPS)

EPS indicates how much money a company makes for each equity share. This is obtained from Net Income. When the company records a higher profit, the EPS increases. A higher EPS indicates that the company’s profitability is growing significantly. 

Price to Earnings (PE)

PE Ratio shows the price investors are willing to pay to buy a share in the company’s earnings. When the company’s earnings grow, the investors also show high confidence and trust in the company’s prospects. This is reflected in the PE ratio. When the PE ratio expands, it indicates that the investors are willing to pay a higher price for each rupee of earnings.

So, net income growth, EPS and PE ratio are the drivers because they contribute to a higher valuation for the company, leading to a higher stock price.

Things that Affect Total Shareholder Return

Cost Cutting

You would think that cost-cutting is great because it saves a company’s revenues and increases margins. Well, that’s not true in all situations. For example, in the hospitality industry, a hotel or resort that reduces its investment in maintenance, upgrades, and guest experience may see improved short-term profitability due to cost savings. However, over time, this could result in negative reviews, decreased customer loyalty, and a decline in bookings, affecting the business’ long-term growth.

Hence, as an investor, it is essential to understand the reason behind the higher margins recorded by the company. 

Declining PE Multiple

The overall investors’ perspective on a stock is a critical driver of TSR. If the company’s PE trend is declining, it means that the investors are losing optimism in the stock. Hence, it is important to look at a five-year PE trend of a stock. 

Dividend Yield While Calculating TSR

When calculating a stock’s Total Shareholder Return (TSR), the dividend yield is considered, but it does not directly impact the TSR calculation. In other words, dividend yield is not the driving factor behind TSR. While dividends are generated from the cash proceeds of the business, it is not mandatory for a company to pay them out.

For instance, growth stocks typically do not pay dividends, yet they can still generate a high TSR because investors anticipate that the company will generate substantial cash flows in the future.

On the other hand, companies operating in the oil and gas or energy sector often have significant capital expenditures but still, generate high free cash flow. These companies frequently distribute dividends to shareholders because their business expansion opportunities are limited. As a result, the TSR of such companies tends to be stable, with dividend yield playing a significant role for investors rather than capital appreciation.

In conclusion, calculating the Total Shareholder Return (TSR) is an important factor to consider when making investment decisions in stocks. However, it is not the sole determinant of a stock’s potential. It is also crucial to assess other ratios and factors, such as the trend of the Price-to-Earnings (PE) ratio and the company’s profit margins.

By considering all of this, investors can better evaluate stocks, avoid potential underperformers, and identify promising investment opportunities. These factors help distinguish potential diamonds from less favourable choices in the stock market.

*The article is for information purposes only. This is not investment advice.

Note: This article was originally written by Teji Mandi for ET Markets.

Read the article here.

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