Question

3. If a company performs perfectly in line with expectations, how will its TRS react in theory? How will its TRS react in practice? Why?

Answer 1

TRS or a total return to shareholders is computed using the formula: TRS = percentage change in share price+dividend yield. This can be further expanded to TRS = percentage increase in earnings+percentage change in P/E+dividend yield

If a company performs perfectly in line with expectations its TRS will increase as per expectations, in theory. However in practice it may not increase because managers might assume that all forms of earnings create an equal amount of value. In reality all forms of earnings do not create the same level of value as different sources of earnings growth create different amounts of value. Secondly, in reality dividends do not create value; they are just residual in nature. So in reality TRS will witness a lower quantum of increase than in theory.