Unless an owner has the chance to influence or control operations, only these two possible benefits can accrue: appreciation in the value of the stock price and cash dividends. Question: An investor can put money into a savings account at a bank and earn a small but relatively risk free profit. For example, $100 could be invested on January 1 and then be worth $102 at the end of the year because interest is added. The extra $2 means that the investor is earning an annual return of 2 percent ($2 increase/$100 investment). How is the annual return computed when the capital stock of a corporation is acquired? Answer: Capital stock investments are certainly not risk free. Profits can be high, but losses are also always a possibility. Assume that on January 1, Year One, an investor spends $100 for one ownership share of Company A and another $100 for a share of Company B. During the year, Company A distributes a dividend of $1.00 per share to its owners while Company B pays $5.00 per share. On December 31, the stock of Company A is selling on the stock market for $108 per share whereas the stock of Company B is selling for $91 per share.
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The investor now holds a total value of $109 as a result of the purchase of the share of Company A: the cash dividend of $1 and a share of stock worth $108. Total value has gone up $9 ($109 less $100) so that the annual return for the year was 9 percent ($9 increase/$100 investment). The shares of Company B have not performed as well. Total value is now only $96: the cash dividend of $5 plus one share of stock worth $91. That is a drop of $4 during the year ($96 less $100). The annual return on this investment is a negative 4 percent ($4 decrease/$100 investment). Clearly, investors want to have all the information they need in hopes of maximizing their potential profits each year. A careful analysis of the available data might have helped this investor choose Company A rather than Company B.
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