Question

	Stock X ($)	Stock Y($)
Investment Value
1 January	30	50
31 December	29	56
Dividends received
Q1	1	0
Q2	1.2	0
Q3	0	0
Q4	2.3	2

1. For both stocks X and Y, calculate the holding period return (over one year) for both stocks.
2. If you continue holding these two stocks beyond the first year, which component do you think might not continue to be realised in future (explain)
3. Assuming that the two stocks have the same risk, which one would you prefer to own?
4. What factors could explain why the return of these two stocks is not in the same form?                                          

Answer 1

a) For Stock X

Capital Gains yield = (Final price - Initial price)/Initial Price = ($29-$30)/$30 = -3.33%

Current Gains Yield/Dividend yield

= Dividends paid over the year/ Initial Price

= ($1+$1.2+$2.3)/$30 = 15%

So, Holding period yield = Capital Gains yield + Dividend yield = -3.33%+15%= 11.67%

For Stock Y

Capital Gains yield = (Final price - Initial price)/Initial Price = ($56-$50)/$50 = 12%

Current Gains Yield/Dividend yield

= Dividends paid over the year/ Initial Price

= ($2)/$50 = 4%

So, Holding period yield = Capital Gains yield + Dividend yield = 12%+4%= 16%

b) As dividends of a company is generally not changed and is dependent on the excess cash of the company dividend yield is generally more stable than the capital gains yield which is also highly dependent on market perceptions.

So, If both the stock are held for more than one year, the capital gains yield may not continue to be realised in future.

c) I would prefer to own Stock Y as it has a higher holding period yield over the Stock X at the same risk.

d) The returns of the two stocks may be different because of many different factors.some of them may be:

1. The stocks may belong to different industry sectors, so sector specific risks may affect one stock more than the other

2. The growth rate, size etc of the companies may be different

3. One year different returns may not be a suitable measure to assess whether the returns of the two stocks are actually different in the long run.