Capital gains yield (CGY) refers to the profits or losses an investor earns on a financial instrument that appreciates or depreciates in price during the time the investor possesses it. In other words, CGY indicates the rate of change of the price of the financial instrument. Many investors choose to calculate the CGY of an investment tool because the formula usually gives a good indication of how much the price of the tool fluctuates; this helps the investor determine which tools are good investment choices. Capital gains yield is commonly expressed as a percentage.
The formula to calculate capital gains yield is: CGY = (P1 - P0) / P0. P0 represents the original price of the financial instrument, while P1 stands for the current price or selling price of the instrument. For example, if an investor buys a share for $10 US Dollars (USD) and later sells it for $15 USD, the capital gains yield would be (15 - 10) / 10 = 5/10 or 50 percent.
There are other ways to express the CGY formula. It can be stated as (ΔP) / P0, where ΔP represents the change in price. A rearrangement of the original formula gives (P1 / P0) - 1.
Capital gains yield is not cumulative, so if the yields for several periods of time are known, it is not possible to find the yield for the entire period just by adding all the yields of the different periods. For example, there is no way to determine the annual capital gains yield just by adding all the monthly yields for the year. Instead, the initial price at the beginning of the year and the price at the end of the year must first be known and plugged into the CGY formula to find the annual yield.
Other Factors Not Included
Capital gains yield does not represent the total return of an investment, nor does it take into account cash flows such as dividends. As a result, a financial instrument that has a negative CGY could still generate profits for the investor. Capital gains yield only equals total return if the financial instrument generates no cash flow.
For example, if an investor originally pays $60 USD for a share and later sells it for $58 USD, his CGY would be negative: (58 - 60) / 60 = -3.33 percent. If he gets a $5 USD dividend during his holding period, though, he would still be able to show an overall profit of $3 USD.
Despite some factors being excluded from the formula, CGY can still be a beneficial formula for investors trying to calculate price fluctuation over a period of time.