Yield on Common Stock

The rate of return that sets the discounted value of the expected cash dividends from a share of common stock equal to the share's current market price is the yield on that common stock.

If, for example, the constant dividend growth model was appropriate to apply to the common stock of a particular company, the current market price (P0) could be said to be

P0 = D1 / (keg)    (4.26)

Solving for ke, which in this case is the market-determined yield on a company's common stock, we get

ke = D1P0 + g    (4.27)

From this last expression, it becomes clear that the yield on common stock comes from two sources. The first source is the expected dividend yield, D1/P0; whereas the second source, g, is the expected capital gains yield. Yes, g wears a number of hats. It is the expected compound annual growth rate in dividends. But, given this model, it is also the expected annual percent change in stock price (that is, P1/P0−1=g) and, as such, is referred to as the capital gains yield.