What it means
A share can reward its owner in two ways. The price may go up, and the company may pay dividends.
TSR adds the two together, so a company paying generous dividends with a flat price can score the same as one paying none whose price has grown. The measure is usually calculated over a period of one, three or five years, and for longer periods it is often shown as an annualised figure.
It assumes that dividends are either kept as cash or reinvested in more shares, and the second approach gives a slightly higher result because the dividends earn returns of their own. TSR is widely used to compare a company against its peers or a market index.
A company may report that its three-year TSR was 40% against a sector average of 25%, which suggests that it has created more value for owners than its competitors have, though the comparison is only fair if the same dates are used. It also appears in executive pay.
Many companies tie part of their long-term bonuses to relative TSR, meaning the company's return ranked against a group of rivals. That aligns managers with shareholders, though it can also reward luck in a rising market or encourage short-term thinking.
TSR has limits. It depends on the start and end dates chosen, it is affected by market swings the managers cannot control, and it says little about the underlying quality of the business.
It is best used alongside measures such as return on capital and cash flow. Another point is currency and tax.
Investors in different countries may see different results after tax and exchange rate moves, so published TSR figures are normally pre-tax and in the currency of the listing.
In practice
Real-world examples.
Example
An investor compares two mature companies. Company A rose 3% in price and paid a 5% dividend yield, while Company B rose 6% and paid no dividend, so A's TSR of 8% beat B's 6%.
Example
A remuneration committee sets a long-term bonus that pays out in full only if the company's three-year TSR ranks in the top quarter of 20 peers. The structure rewards outperformance rather than a general market rise.
Example
A CFO presents the annual results and shows a five-year TSR chart against the sector index. The chart makes a point that revenue growth alone does not, since it shows how investors have actually fared. He also explains how the dividends were treated in the calculation.
Formula
Calculation
TSR = (Ending share price - Beginning share price + Dividends received) / Beginning share price x 100
An investor buys a share for $50. A year later it is worth $56, and during the year the company paid dividends of $2 per share.
TSR = (56 - 50 + 2) / 50 x 100 = 8 / 50 x 100 = 16%. Of this, the price change contributes 6 / 50 = 12% and the dividends contribute 2 / 50 = 4%. For 1,000 shares, the investor's gain is 1,000 x 8 = $8,000 on a $50,000 investment. Note that 8,000 / 50,000 = 16%, which matches the per-share result.Case study
Seen in the real world.
Ironvale Holdings is an illustrative, fictional manufacturer whose share price rose from $40 to $46 over a year. The company paid $1.60 in dividends, and its chief executive claimed a good year.
The CFO calculated TSR as (46 - 40 + 1.60) / 40 = 7.6 / 40 = 19%. The sector's average was 24%, so the company had lagged its peers even though its price had risen.
The illustrative lesson is that a rising price is not enough on its own. The board set a goal to reach the top half of its peer group on TSR over three years, and linked 30% of executive long-term bonuses to that goal. The board also agreed to publish the TSR calculation in the annual report so that shareholders could check the figures.
Watch out
Common mistakes.
- Looking only at the share price and leaving out dividends, which understates the return.
- Comparing TSRs over different time periods, when the start and end dates change the result a great deal, particularly after a market crash or a sharp rally.
- Treating TSR as a measure of management skill, when market moves outside the company's control also affect it.
Questions
People also ask.
What is a good TSR?
It depends on the period and the market, so the useful test is how it compares with peers and an index over the same dates.
Does TSR include reinvested dividends?
It can, and the calculation method should be stated, since reinvestment raises the result slightly.
Why do boards care about TSR?
It summarises what shareholders have actually received and is easy to compare, which is why it is used in pay plans and in investor presentations.
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