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When we say that the average annualized return of a stock XYZ over the last 5 yrs is 7%, how do we factor in dividends?

For example, let us say, if XYZ was at 100$, and at the end of year 1, it was 105 ;

at the end of year 2, it was 110 ;

at the end of year 3, it was 115 ;

at the end of year 4, it was 120 ;

at the end of year 5,it was 125.

And each quarter, it paid a dividend of 1$/share, then what will be the average annualized return?

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You simply add the dividend to the stock price when calculating its annual return.

So for year one, instead of

(105-100)/(100) = 5%

it would be

(105+4-100)/(100) = 9%
  • Thanks, did not realize it was that simple. – Victor123 Mar 22 '15 at 15:15
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    This is only an approximation if the dividends come quarterly. You need to compute quarterly returns in this manner and then use them to get the annual returns. R_annual = (1+R1)(1+R2)(1+R3)(1+R4) -1 – farnsy Mar 22 '15 at 17:09
  • Yes, but if you're going to incorporate time value into your dividends then you need to know both the time horizon and the dividend pay date – Matthew Mar 22 '15 at 17:27
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    ... and next step would be to factor in the tax rate so your back-tests yield real-life results. For instance, I would run the full $4 dividend on tax-shielded accounts, but normal accounts I'd use $3.60 for an after tax ROI. 8.6% = (105+(4*.9)-100)/(100) – Knuckle-Dragger Mar 22 '15 at 20:15

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