Return of Investment (ROI) measures the profitability of an investment, expressed as a percentage.
To calculate the ROI of an investment, simply divide the dollar amount of the profit of the investment by the dollar amount of the cost of the investment, and then multiply by 100. Expressed mathematically:
(Profit of investment / Cost of investment) * 100
For example, if you invested $10,000 in the stock of a company and later sell it for $20,000:
Step 1: Calculate the profit, which is the value of the investment minus its cost (i.e., $20,000 – $10,000 = $10,000).
Step 2: Divide the profit by the cost (i.e., $10,000 / $10,000 = 1).
Step 3: Multiply the result by 100 (i.e., 1 * 100 = 100). Thus, your ROI in this example is 100%.
You must understand the assumptions of this example:
First, it assumes that no dividends were paid “along the way.” Many companies, for example, pay dividends to their shareholders and this example assumes that none were paid. But what if they were?
For example, assume the same facts as above but also assume that the day before you sell your stock for $20,000 that you were paid a $1,000 dividend. In that case, the math above would be replaced by this:
Step 1: Calculate the profit, which is the value of the investment minus its cost (i.e., $21,000 – $10,000 = $11,000).
Step 2: Divide the profit by the cost (i.e., $11,000 / $10,000 = 1.1).
Step 3: Multiply the result by 100 (i.e., 1.1 * 100 = 110). Thus, your ROI in this modified example is 110%.
Notice, by the way, that the modified example assumes that the dividend was paid the day before you sold your stock. We made this assumption to avoid having to bring into this discussion the time value of money.
Also, both examples, ignore:
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