How to Calculate Return on Investment (ROI)
What is ROI?
ROI is one of the oldest and most basic metrics that describes the net profit made after placing an investment. This amount that you make as profit from an investment is also a major apart of the key performance indicator (KPI), which helps describing your financial situation, formulates your long-term strategic planning. On the other hand, if you have to pay your earnings to the investors, you’ll have to pay the returns as dividends for rewarding their investments. ROI describes how much profitable a company actually is and gives a good estimate of its earning and potential.
How to Calculate ROI for Investments
There are many ways which you can use to determine the ROI on investment. Here are two main methods that you can use and instructions to follow for each of them:
Method 1
1. Calculate the net return on investment ROI
Say you purchased 2,500 shares of stock in a company at a price of $10 per share. Assume that you sold those shares after a year for $15 per share and earned $1,000 in dividends over the same period. Now assuming that you also paid $200 in total on trading commissions while buying or selling the shares, here’s how you’ll make the calculations:
First, you’ll need to count in all the capital gains, commissions and dividend paid out to investors to calculate the net ROI.
Net ROI: [($15 - $10) x 2,500 + $1,000 - $200 x 100 %] = $13,300
2. Calculate the cost of total investment
Simply multiply the per share price with the total number of shares you own.
Cost of Investment: $10 x 2,500 = $25,000
3. Divide the net ROI by the COI
The final involves dividing the ROI by the COI to get the final ROI ratio or ROI in percentage. In this example the ROI comes out to be a whopping 53.2 percent, which by the way is quite unrealistic.
Method 2
1. Subtract the final value of investment from the initial value
First, you’ll need to identify the initial value of investment. For example, let’s say that the $200 in trading commissions you paid, as in above example, are split up into two: $120 while buying and $80 while selling. Here’s what initial value of investment will be:
Let's say that you split the $150 in trading commissions, $60 when buying the shares and $90 when you sold them.
$25,000 (COI) + $120 = $25,120
Now for the final value, you’ll need to weigh in the $1,000 in dividends you received and the $80 you paid for selling the shares in commissions:
$37,500 ($15 per share x 2,500 shares) + $1,000 - $80 = $38,420
Now subtracting both the values, we get:
$38,420 - $25,120 = $13,300
2. Divide this number by COI
Now divide the $13,300 by the total COI, which in this example is $25,000 and you’ll get a ratio of 0.532.
3. Multiply this ratio by 100
Multiplying 0.532 with 100 will give us a 53.2 percent ROI for our example.