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what is roi

90 Second Lessons: What is ROI?

What is ROI and How is it Calculated?

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:

  • any fees that may have been paid in connection with buying or selling the stock;
  • taxes; and
  • how long you owned the stock (which is another example of us avoiding the need to bring into this lesson a discussion of the time value of money). For now, let it suffice to say that if you owned the stock for 10 years and your ROI is 100% ROI, then your annual ROI (assuming no compounding of returns) was only 10%.

[Editors’ Note: To learn more about this and related topics, you may want to listen to the following webinars:

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