What Is Stock Duration?

Stock duration is a term that is often associated with the structure of equity stock options and has to do with the relationship between the change in the price of those shares and a change in the delivery of returns on those shares over the long-term. Understanding how shifts in pricing will impact the returns generated by the stocks make it easier for investors to project anticipated returns if the shares are held for a specified period of time, allowing for the incidence of price change and the resulting shift in returns. Assessing stock duration involves the ability to identify market trends and apply them to the stocks in question, resulting in the ability to better understand the chances of earning a profit from the holding.

Projecting the stock duration typically involves utilizing a specific formula to determine what is known as the dividend discount. In order to make use of this approach, it is necessary to identify the discount rate that applies to the stocks as well as the anticipated rate of growth for that stock over a specified period of time. The approach will require allowing for a 1% shift in the anticipated return, with that shift being positive or negative based on what is expected to happen in the marketplace.

Depending on what is likely to occur with the market value of the stock during the period under consideration, the stock duration may indicate a favorable return or one that is less than desirable. Using this information, the investor can decide if the asset is worth acquiring or holding onto, or if the asset should be sold in favor of acquiring stocks with a more attractive duration. The process is only effective if the movement of the market and the effect on the returns generated by the stock are accurate. Should the stock perform in a manner that is different from the projections, that favorable gain may turn into a loss, or vice versa.

As with most strategies used to anticipate growth with an asset, stock duration calls for accurately assessing what will happen with the stock in the future. Doing so makes it easier to identify if movement in the future is likely to be favorable, what impact changes in interest rates may have on the dividends that are generated, and even if the anticipated growth is sufficient to merit buying and holding the shares. One benefit of projecting stock duration is that the process does motivate investors to consider the market in more detail, something that may also be helpful in evaluating the potential of other holdings traded in that same market.