When calculating the return on investment of a security, you’ll review the appreciation of that stock over a certain period. As you do, you’ll need to know whether you’re looking at closing prices or adjusted closing prices. What is an adjusted closing price? It’s one that accounts for any corporate action that might’ve affected share price outside of market sentiment. Looking at closing prices vs. adjusted closing prices can significantly change the measure of your ROI!
Here’s what you need to know about adjusted closing price, what it includes, and how it impacts your ROI calculations. Keep in mind that not every company’s adjusted closing price will differ greatly—only those with consistent corporate action, such as dividend payouts.
Breaking Down Adjusted Closing Price
The price the stock ends at when trading halts for the day is its closing price. Mathematically, that price, multiplied by the number of total shares, represents the value of the company. The problem is, it’s not always reflective of the company’s true value.
Say, for example, ABC Company had a neutral trading day and remained flat. However, it also paid a 2% dividend today. But did the company really lose that value? Rather, how did the dividend payout affect the stock price of the company and its value? This discrepancy is one example of why adjusted closing price is important.
Adjusted closing price accounts for corporate actions affecting share price. This allows a more accurate depiction of return on investment by more accurately measuring the change in stock price after something like a dividend payout or a stock split, which affects closing price and company valuation.
The Formula for ROI Using Adjusted Closing Price
Most financial websites provide the adjusted closing price. Provided you have the inferenced data regarding the share price after corporate action, you can use it to calculate stock ROI. The formula is as follows:
(AC1 – AC0) / AC0
- The AC1 is the adjusted close one trading day into the future
- The AC0 is the adjusted close of the specified day of action
This formula is important because it shows you a more accurate ROI to account for actions outside of investor sentiment. It’s widely considered the most accurate way to address price movements in context.
What Factors Affect Adjusted Closing Price?
“Corporate action” can take many forms. Typically, adjusted closing prices reflect the most common types of price action associated with creating shareholder value. Examples include:
- Dividend Adjustments. Dividends are still part of an investor’s return, which makes it important to factor them into a historical evaluation of ROI. Adjusted closing price accounts for the rate of return on those dividends, to reflect it in a single historical review of the company’s performance—instead of requiring investors to add dividend ROI separately.
- Stock Split Factors. Splits make the company’s share price more accessible to retail investors, but do not affect the company’s total value. If after the split, adjusted share price will reflect an accurate representation of the company’s value across the new shares. For example, if the company does a 1:2 stock split at a $500 price, the new share price would be $250. Then, all previous share prices would adjust by that same 50% ratio.
- Adjustments for Rights Offerings. Rights offerings typically dilute share price, which can have disruptive effects on historical evaluation of stock performance. Adjusted closing price factors this in to provide a more representative trend line based on the true value of the stock outside of the offering.
All in all, any adjustment to the share price of a stock that’s the result of company governance tends to benefit from adjusted closing price. Adjustments ensure anomalies don’t obscure relevant historical data.
The benefit (and purpose) of adjusted closing price is to make historical evaluation of ROI easier. Because it accounts for corporate action, it provides a better data point within a trendline where an anomaly might otherwise exist. For example, if ABC Company announces a 1:2 stock split, investors don’t lose half their value. Adjusted closing price recognizes this.
In addition to doing a deep-dive on ROI for an investment, adjusted closing price also makes it easier to compare stocks. For example, if you’re comparing the performance of two dividend-payers, you’ll want to do so from an adjusted closing price standpoint. Not accounting for dividends in the closing price can take away from the perceived profitability of investments and skew comparison.
Like most investing metrics, adjusted closing price isn’t without its drawbacks and criticisms. Most critics rightfully point out that the actual closing price of a stock has valuable information, such as the breakout point in a charting pattern. An adjusted closing price can disrupt technical analysis. It’s also a less useful metric for speculative investing for the same reasons.
There’s also some concern that adjusted closing price can create false sentiment that sways investors around pivotal stock price points. For example, popular stocks like Tesla (NASDAQ: TSLA) see heavy investor activity at key price levels, such as $100 and $400. Adjusted closing price for these stocks can obscure true support and resistance levels, disrupting investor analysis.
Always Consider ROI Using the Right Variables
What is an adjusted closing price? For many investors, it is a more accurate data point they can use to calculate the real ROI of their investment over time. It’s not always easy to account for stock splits and dividends. Therefore, sign up for the DailyBusiness e-letter below and become more advanced in your investment journey.
Adjusted closing price enables a more holistic view of ROI, regardless of the factors at-play. It’s a shortcut to understanding the real returns on your well-performing portfolio. Just make sure you’re not doubly factoring in dividends or splits in other calculations!