Although amateur investors purchase stock with a vague notion -- or, more accurately, a hope -- that it will provide returns, seasoned investors need more than gut feelings to determine a stock’s profitability. One tool to help predict the return on a stock investment is the market capitalization rate, also known as expected return, which can be used to project a stock’s potential earnings over a period, or to evaluate a stock’s performance over a historical period. Investors can then use these figures to compare stocks’ valuation and profitability when compared to other types of investments.
1. Determine the total number of dividends over the period for which you will calculate the stock’s market capitalization rate. Historical data may be used to roughly predict future dividends in the absence of other data. Make variable D represent this figure. For example, the Widget Corp. paid quarterly dividends of $2, $2.50, $1.50 and $2, so in this example D equals 8.
2. Determine the price at the beginning of the period you’re evaluating. Usually, this is your purchase price, either historically or now, if you purchase it. Set this value as variable P. Assume that the Widget Corp.’s stock cost $1.75 when you purchased it a year ago, so in the example, P equals 1.75.
3. Determine the price of the stock at the end of the evaluation period. This is either an estimate of its future price, or if examining historical prices, its current price. Set this value as p. In the example, Widget Corp. stock trades for $2.25 per share, so p equals 2.25
4. Apply variables into the formula to determine market capitalization rate, variable R. The formula is: R = (D + p – P)/p. In this example, R = (8 + 2.25 – 1.75)/1.75 R = 4.85