What Does Return on Investment (ROI) Mean?
Return on investment (ROI) is a performance measure that is used to evaluate the efficiency of an investment or to compare the efficiency of several different investments. It measures the gain or loss generated on an investment relative to the amount of money invested. ROI is a very popular metric because of its versatility and simplicity.
Divestopedia Explains Return on Investment (ROI)
As a performance measure, a ROI describes an investment's benefit to the investor. It is typically used for personal financial decisions, to compare a company's profitability or to compare the efficiency of different investments.
To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or ratio. The return on investment formula is :
ROI = (Net Profit / Cost of Investment) x 100
The ROI calculation is flexible and can be manipulated for different uses. A company may use the calculation to compare the ROI on different potential investments, while an investor could use it to calculate a return on a stock. If an investment does not have a positive ROI, or if there are other opportunities with a higher ROI, then the investment is usually not undertaken.
For example, suppose that an investor buys $2,000 worth of stocks and sells the shares two years later for $2,200. The net profit from the investment would be $200 and the ROI would be calculated as follows:
ROI = (200 / 2,000) x 100 = 10%
In this case, the ROI is 10%.
The calculation can be altered by deducting taxes and fees to get a more accurate picture of the total ROI. The same calculation can be used to calculate an investment made by a company. However, the calculation is more complex because there are more inputs. For example, to figure out the net profit of an investment, a company would need to track exactly how much cash went into the project and the time spent by employees working on it. ROI is one of the most used profitability ratios because of its flexibility. That being said, one of the downsides of the ROI calculation is that it can be manipulated, so results may vary between users. When using ROI to compare investments, it's important to use the same inputs to get an accurate comparison.