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Research on the common stock of the Walt Disney Company, a worldwide entertainment company
with operations in media networks, parks and resorts, studio entertainment, and consumer products,
shows Disney‟s stock price at the beginning of 2006 was $23.97 per share and at the end of 2006 was
$34.27 per share, and its stock paid cash dividends per share of $0.31 in 2006. With these data, we are
able to calculate the year 2006 holding period return to an investor in Disney‟s common stock as:
During 2006 investors in Disney common stock were well rewarded, earning a dividend yield of
1.29% and a capital gains yield of 42.97%, which combine to produce a total return of 44.26%.
Many firms collect, analyze, and publish information about the returns earned by alternative
investments. Ibbotson Associates, Inc., which publishes data showing, among other items, the average
annual returns earned by different investments over different holding periods, is a well known and
widely cited authority in this area. A selected group of average annual returns for the 80-year holding
period from 1926 through 2005 is presented in Exhibit 5.2, which shows that investors in small
company stocks earned the highest average returns over this 80-year holding period, and investors in
U.S. Treasury bills earned the lowest average returns.
Exhibit 5.2 Average annual returns, 1926-2005.
Source: Modified from Stocks, Bonds, Bills, and Inflation: 2006 Yearbook, Ibbotson Associates, Inc.
Exhibit 5.2 also reveals the positive relationship between risk and return, as small company stocks
have the highest risk of the investment series shown in the table, and U.S. Treasury bills have the
lowest risk.
Now that we have discussed how to measure investment returns, we will move on to measuring
investment risk.
Measuring Risk
The risk of any investment is defined by the variability of the investment‟s returns. Investments with
low variability of returns have lower risk, as their returns are more predictable. Investments with high
variability of returns, in contrast, have higher risk, as their returns are less predictable. This variability
can produce both better than predicted returns and worse than predicted returns, so we will measure
variability of returns in both directions, upside and downside. We will begin our look at risk by