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Total shareholder return (TSR) is a financial performance indicator that shows how much value an investment in a business has produced for its shareholders over a specific time frame. It is also a good statistic for assessing how well various stocks or businesses have performed.
TSR considers both capital gains (or losses) and dividends (or other distributions) that a stockholder gets. Capital gains are the difference between the stock's market price at the time of purchase and the price at which it was sold (or the current price if it is still owned). Dividends are payments made per share from earnings or reserves by some businesses to their shareholders.
To calculate TSR, we need to know the stock's initial purchase price, its current market value or selling price, and any dividends that were paid out while the stock was held. The formula for TSR is:
TSR = ((Current Price - Purchase Price) + Dividends) / Purchase Price
As an illustration, let's say that on January 1st, 2020, an investor purchased 100 shares of Company A for $10 each. Company A's stock price was $12 on December 31, 2020, and the company paid a $0.50 dividend per share. The investor's TSR for 2020 would be:
TSR = (($12 - $10) + $0.50) / $10
TSR = ($2 + $0.50) / $10
TSR = $2.50 / $10
TSR = 0.25
TSR = 25%
This indicates that in 2020, the investor will have received a 25% return on their investment in Company A.
Why Is Total Shareholder Return Important?
Total shareholder return is crucial because it serves as a clear indicator of the total financial gains that a business or stock has produced for its investors. Investors can use it to assess how well their investments are doing and whether their expectations are being met.Managers and board members can evaluate their performance in generating value for their shareholders and determine whether they need to change their strategies or policies by looking at their total shareholder return. For instance, some businesses base executive salaries or incentive schemes on TSR.
However, total shareholder return also has some limitations that should be considered when using it as a measure of performance or value creation. Some of these limitations are:
- TSR is based on historical performance and does not account for potential or risk for the future.
- Investor mood and market circumstances, which can be erratic and volatile, have an impact on TSR.
- TSR does not take into account variations in risk-adjusted returns among various equities or businesses.
- Other aspects like corporate governance, social responsibility, environmental effect, etc. that could have an impact on shareholder value are not taken into account by TSR.
Total shareholder return should therefore not be viewed as the only metric for measuring performance or value creation, but rather as one of many that can shed light on how well a business or stock is performing for its shareholders.
