What is Capital Gains Yield Formula, Explained with Examples
Many people are aware of the concept of capital gains when it comes to profiting from the sale of an asset. But the term capital gains yield formula is a calculation less known. That is unless you work in a commercial or trading environment.
But if you’re looking to invest in any type of security, this is an effective formula that can act as a useful tool.
Understanding the use of the capital gains yield formula helps better investment decisions. This means you could look at making a profit as a result of applying it.
Here we simplify the formula of capital gains yield, breaking it down into its basic terms. Then we analyze it in a little more detail, offering a worked example.
What Is Meant by Capital Gains Yield Formula?
Simplified, capital gains yield formula refers to investments or securities price appreciations. This is expressed via way of a percentage.
A term often abbreviated to CGY; the formula offers total returns from an investment. This is the component that occurs due to a rise in the securities market price.
Thus, capital gains yield formula helps investors determine what potential yields could be. This means finding a profit when holding an asset.
The Formula Used for Capital Gains Yield
You may see the CGY formula treated in two different ways. Though the results are the same, the first calculation’s written as:
This is perhaps the simpler of ways to write the formula. It’s helpful for those that don’t work in the finance sector or have minimal trading experience. It’s also often easier on the eye for those who don’t really like the look of formulas!
The second way you may also see this calculation written is as:
A more formulaic version, when broken down this simply means here:
P1 The price of the stock when it was invested in
P0 The price of the stock after the first period
Capital Gains Yield Formula in Action
Now that we know the formula for capital gains yield, it’s easier to put it into use. Here is an example of CGY in play.
Let’s say that Mia is looking at buying shares in the company called BZD. These shares will cost her $200 at market price. During the year after purchasing BZD shares appreciate to £250.
Meanwhile, by the end of the first year, BZD decides to issue dividends of $7 per share to all its investors.
By applying the capital gain yield formula here, we can work out Mia’s end profit as:
($250 – $200)/100= 50%
Yet, we also need to do another calculation here. This is for the dividend gain yield for Mia’s investment which in this case, is $7.
7/100 = 7%
So, the totals return made on the BZD investment is 57%
Explaining the Capital Gains Yield Formula Further
Now you know the formula and can see it being used in action. You may be wondering when exactly you yourself would need to use it.
The capital gains yield formula is usually used by investors when a change in prices occurs.
This is a change concerning the stocks buying price and the stocks selling price. It’s primarily used when such change occurs within the time frame of one year.
Thus, as an example of this, should stock appreciate, and the investor sells at a premium price – the difference here means an entitlement to a short-term capital gains tax.
But, if there’s no positive return on a security, then there’s no point of capital gains. This means the selling price is higher than the buying price. This may occur in several instances.
What You Need to Know About the Use of Capital Gains Yield Formula
When calculating capital yield gains, there are limitations. But there are also advantages to accessing this formula. Here we highlight both:
- Capital gain yield involves only the market price of your security over time.
- The capital gain yield formula, therefore, employs the use of change formula.
- The capital gain yield can be positive or negative, or it can be a capital loss
- An investment that doesn’t have a negative capital gain yield may be able to generate profits for an investor
- CGY can help when analyzing the extent of any fluctuation in the security market price.
- We can’t derive much information about an investment, purely from its capital gain yield.
- Capital gains are higher when the share price is higher during a specific period
- Higher capital gains state a higher stock performance
- When calculated, capital gains use of the formula is related to what’s called a Gordon growth model.
- Capital gains yield can occur monthly or quarterly or even annually.
- CGY is unpredictable!
- Capital gain yield differs from that of dividends.
- Dividends are paid at a pre-defined period.
- Capital gains yield cannot be generated for security if prices fall below original purchase prices.
- Capital gains can, at times, result in a need to pay capital taxes.
- Investors can look to offset capital gains taxes through loses. Or they can carry them over to the following year.
Who Can Benefit from the Capital Gains Yield formula?
There are many investors who choose to employ the capital gains yield for their securities. This is primarily because this is the formula which can highlight the fluctuation of price.
Thus, the formula can significantly aid an investor looking to decide which of those securities are the better to invest their money in.
Finding Your Capital Gains Yield Formulas on Excel
If you’re keen to get started figuring out CGY, you may find using Excel’s a great help!
Spreadsheets can work to calculate your formula more effectively. Many websites offer excel template downloads for this very purpose.
All you end to work on excel in this instance is information on:
- Settlement Dates – These are the dates when you purchase your security.
- Maturity dates – These tell you the dates when your security is due to expire.
- Coupon Rates – These are the rates that are fixed and guaranteed to payout annually.
- Price Details – This refers to the price of your security per $100 of its face value.
- Redemption Values – These are the values of the bond redemptions and are stated per $100 of that at face value.
- Frequency – This relates to the coupon payments and the numbers made per year. Such payments will tend to be made on a quarterly, semi-annually, or annual basis.
- Basis – Though this is an optional entry when it comes to using Excel, the program will revert to a 360 standard count if it’s omitted. Basis refers to the annual day count that is needed for your calculation.
Rates can be placed in the appropriate cells on a spreadsheet, while the formulas entered manually in a bid to enter the yield of the current bond.
It does, however, pay to be aware here that bond prices change over time. Thus, the current yield will vary. If you’ve manually entered all your formulas here, your calculation won’t consider this price change as such.
But you can refer to the more complex of calculations which are employed by analysts. This is one which is referred to as YTM, or Yield to Maturity.
A YTM calculation will automatically determine the bonds anticipated yield. This will consider any capital gains, or any losses experienced that is due to price fluctuations.
In addition to Excel, many websites offer a capital gains yield calculator whereby the calculator does all the work for you!
Final Thoughts on Capital Gains Yield Formula
In concluding, by understanding the formula of capital gains yield, you’ll see how easy it is to implement with your own financial decisions. You’ll also be able to decide whether it’s relevant to your future investment choices.
Thus, each time you come across an investment, you can increase your chances of gains by acknowledging the potential for profit in the process, using what you now know.