THE BEECHMONT CREST ONLINE GUIDE TO STOCKS AND INVESTING
Holding Period Return (HPR) / Holding Period Yield (HPY)
When evaluating two alternate investments, it is necessary to compare them on an “apples to apples” basis.
For example, suppose you are weighing the stock of a high-tech start-up company against an established blue chip stock. The stock of the high-tech company sells for $20, and pays no dividends. The stock of the blue chip company sells for $100 and pays annual dividends of $4. These two stocks are wildly different, but which one is the better investment?
The first step is to derive the holding period return (HPR) of each stock. The HPR is the change in wealth resulting from the investment. The change in wealth can come from a.) interest or dividend income arising from the investment, or b.) a change in the price of the investment. For the purpose of this example, we are going to assume knowledge of the future, and project the HPR/HPY of each investment at the end of the coming year. (In real life, you could substitute this future-based analysis with and analysis of past performance.)
First, Calculate the HPR / HPY of the Blue Chip Stock
Suppose that you spend $1000 on ten shares of the blue chip stock. At the end of the year, you have $40 in dividends (10 shares x $4); and the price of the stock rises to $110/share. The HPR for this investment would be calculated as follows:
HPR = ending value of investment / beginning value of investment
= $1,140 / $1,000 = 1.14
Next, convert the HPR to an annual percentage: the holding period yield, or HPY. The HPY is the HPR minus 1:
HPY = 1.14 – 1 = 14%
Calculating the HPR / HPY of the High-Tech Stock
Now, let’s look at the HPR/HPY of $1000 spent on the high tech stock, in the event that it rises to a price of $25/share. Since we were able to buy 50 shares of the stock with $1,000 at the original price, the value of the stock at the end of the year would be 50 shares x $25 = $1,250:
HPR = $1,250 / $1000 = 1.25
HPY = 1.25 – 1 = 25%
So in this comparison, the high-tech stock would be a better investment even though it pays no dividends, because of its increase in value.