Return on Investment (ROI)

Return on Investment (ROI)

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What Is Return on Investment (ROI)?


Return on investment (ROI) is a performance measure used to evaluate the efficiency or profitability of an investment. ROI directly measure the amount of return on a particular investment, relative to the investment’s cost. The higher the ratio, the greater the benefit earned.


KEY Formula

  • Return on Investment (ROI) is a popular profitability metric which is used to evaluate how well an investment has performed.
  • ROI is expressed as a percentage and is calculated by dividing an investment's net profit (or loss) by its initial cost or outlay.


How to Calculate Return on Investment (ROI)

Return on investment (ROI) formula is as follows:

First Method


Example: James invested $1,000 in www.primeshops.co website Buy and Sell Company in 2021 and sold the shares for a total of $1,200 one year later. To calculate the return on this investment, divide the net profits ($1,200 - $1,000 = $200) by the investment cost ($1,000), for a ROI of $200/$1,000, or 20%.

Second Method


Example of the ROI Formula for Property Calculation

An investor purchases property A, which is valued at $500,000. Two years later, the investor sells the property for $1,000,000.

We use the investment gain formula in this case.

ROI = (1,000,000 – 300,000) / (700,000) = 233% profit


Other ROI Formula

There are several versions of the ROI formula. The two most commonly used are shown below:

ROI = Net Income / Cost of Investment

Or

ROI = Investment Gain / Investment Base

Or

ROI = Capital Gains % Commission % + Dividend Yield​It is most commonly measured as net income divided by the original capital cost of the investment.

ROI Formula for Stock Calculation

ROI Formula 

= [(Ending Value / Beginning Value) ^ (1 / # of Years)] – 1

Where:

# of years = (Ending date – Starting Date) /  365

Example: An investor buys a stock on January 1st, 2020 for $12.50 and sells it on August24, 2020, for $15.20.

What is the regular and annualized return on investment?

Regular = ($15.20 – $12.50) / $12.50 = 21.6%

Annualized = [($15.20 / $12.50) ^ (1 / ((Aug 24 – Jan 1)/365) )] -1 = 35.5%


What Is a Good ROI?

Good ROI will depend on factors such as the risk tolerance of the investor and the time required for the investment to generate a return. Investments can take longer to pay off will generally require a higher ROI in order to be attractive to investors.

ROI only emphasizes financial gains when considering the returns on an investment.

Limitations of the ROI Formula

1. The ROI Formula Disregards the Factor of Time: A higher ROI number does not always mean a better investment option.

2  The ROI Formula is Susceptible to Manipulation: An ROI calculation will differ between two people depending on what ROI formula is used in the calculation.

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