Stocks are purchased by investors as a unit of ownership. The goal for most investors is to purchase a stock in anticipation of dividend payments or share price appreciation. That is, they hope to make a return from the investment in the stock. Investment analysts calculate the expected return on a stock by taking the average of a probability distribution. This represents an average of each possible return outcome. The expected return is a statistical guess and may be different from the actual return.
- Skill level:
Look up past return outcomes for a stock over a certain time period to research the probability of at least three possible return outcomes. As an example, assume that XYZ stock has a 20 per cent chance of earning a 5 per cent return, a 40 per cent chance of earning a 10 per cent return and a 60 per cent chance of earning a 15 per cent return.
Calculate the probability of the first outcome. In this case the calculation is 20 per cent multiplied by 5 per cent. The answer is 1 per cent.
Calculate the probability of the second outcome. In this case the calculation is 40 per cent multiplied by 10 per cent. The answer is 4 per cent.
Calculate the probability of the third outcome. In this case the calculation is 60 per cent multiplied by 15 per cent. The answer is 9 per cent.
Sum all three percentages for the average expected return for the stock. The calculation is 1 per cent plus 4 per cent plus 9 per cent equals 14 per cent.
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