Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

ROI - Return on Investment

What is ROI?

ROI (Return on Investment) measures the gain or loss generated on an investment relative to the amount of money invested. ROI is usually expressed as a percentage and is typically used for personal financial decisions, to compare a company's profitability or to compare the efficiency of different investments.

ROI Calculation and Formula

Want to know how to calculate ROI? 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.

For example, an investor buys $1,000 worth of stocks and sells the shares two years later for $1,200. The net profit from the investment would be $200 and the ROI would be calculated as follows:

ROI = (200 / 1,000) x 100 = 20%

The ROI in the example above would be 20%. The calculation can be altered by deducting taxes and fees to get a more accurate picture of the total ROI.

[Easily calculate your return on investment with the CAGR calculator]

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 might need to track exactly how much cash went into the project and the time spent by employees working on it.

How to Calculate ROI (More Examples)

Because ROI can be made as complex or as simple as the measurer wants it to be, it can be used by a variety of different professionals or companies. 

A marketing professional could calculate the ROI of a marketing campaign by dividing the campaign's revenue by the marketing expenses directly involved in that campaign.

So if the marketing department spent a total of $1,000 on material costs and labor hours on the campaign, and it generated $5,000 in revenue for the year, then the campaign had an ROI of 500% -- or ($5,000 in revenue / $1,000 in cost) X 100 = 500% ROI.

A homeowner could calculate the ROI of a given home renovation, too. Let's say the homeowner spent $30,000 to update their kitchen. If the homeowner had the home appraised just before and after the renovation, and found the house gained $45,000 in value, that would mean the renovation yielded a 50% ROI -- or ($15,000 in profit / $30,000 in cost) X 100= 50% ROI.

[Want maximum ROI on home renovations? See the 9 Best Ways to Add Value to Your Home]

What is a Good ROI?

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.

Also, it's important to note that the basic ROI calculation does not take time into consideration. Obviously, it's more desirable to get a +15% return over one year than it is over two years.

[Also see CAGR vs. Average Annual Return: Why Your Advisor is Quoting the Wrong Number]

ROI Frequently Asked Questions (FAQ):

How Do I Calculate ROI Between Multiple Investments?

The typical ROI calculation shows how much an investment yielded overall. However, if you're comparing ROI from two or more investments, the amount of time it takes to make a given return matters too.

For example, let's say an investor is comparing the ROI from two different investments. The investor bought $1,000 worth of shares in ABC Corp. and sold them for $1,400 two years later for an ROI of 40% -- that's (Net profit / Original Investment) X 100 = ($400 / $1,000) X 100 = 40%. 

Then let's say that investor bought $5,000 worth of shares in XYZ Corp. and sold them for $7,500 five years later, for an ROI of 50% -- that's ($2,500 / $5,000) X 100 = 50%.

At first glance, it seems that the XYZ Corp. investment yielded a higher ROI. But when time is considered, the results are different. 

The investment in ABC Corp. returned 40% over two years, while the investment in XYZ Corp. returned 50% in five years. If we divide each of those returns by their respective duration, that means the ABC Corp. investment returned 20% on an annual basis (20% / 2 years) and the XYZ Corp. investment returned just 10% on an annual basis (50% / 10 years).

In other words, even though the investment in XYZ Corp. made more profit overall, the ABC Corp investment generated a higher annual ROI.

[Calculate your annual return on investment with the CAGR Calculator]

Are There Other Ways to Calculate Return than ROI?

Yes, depending on what variables you'd like to be considered there are more precise ways to calculate return on investment. For example, if you're looking to compare returns between investments that have been returning money for different periods of time, then ROI may be divided by the duration of the investment (see the first FAQ question) to get an annual rate of return.

For a measure that takes into account more outside variable, the Real Rate of Return measures an investment's return after adjusting for inflation, taxes, or other external factors.

For individual investors or companies looking to project returns years into the future, the Net Present Value (NPV) finds the expected return of today's investment based on projections of future cash inflows (adjusted for inflation). If the initial cost of the investment exceeds the amount you expect to earn from it after inflation over the next several years, the investment has a negative NPV and will not generate value.

Investors or companies looking to acquire another company may also analyze a company's ROI using different variables that represent the investment cost.

For example, the Return on Assets (ROA) calculation shows a company's return (profit) for every $1 of assets it owns. Meanwhile, the Return on Equity (ROE) formula shows how much a company returned (how much in profit it generates) for every $1 shareholders have in the company's equity.

Learn More About ROI:

7 Ways to Get ROI and Sell Your House Faster

ROI Hacks: The 9 Best Ways to Add Value to Your Home

CAGR vs. Average Annual Return: Why Your Advisor is Quoting the Wrong Number