As an analysis tool, ROI firmly established itself among professional investors, helping them to earn in the long term.
Below you will find out what ROI means, when it’s appropriate, and the pros and cons of the ratio. As practical examples, let’s calculate the ROI for the following assets:
- foreign and Russian stock market shares;
- for the Forex currency market;
- PAMM accounts;
- portfolio investments.
What is ROI in simple terms
Literally translated, ROI is the return on investment (English Return On Investment). All other interpretations of the translation (rate of return, return on investment, return on investment …) are used to easily understand the ROI calculation in relation to various types of investments.
The classic formula for calculating: ROI = Net Income / Investment.
Depending on the goals pursued, the resulting coefficient can be reduced to a percentage (multiplying it by 100).
What is ROI for?
The tool is used to effectively invest in business or financial assets. For different purposes, the calculation method practically does not change:
- If we are dealing with marketing (ROMI), then we get the return on investment in advertising.
- If you plan to invest in a company with long-term profit in mind, then ROI will give a qualitative assessment of the return on future investments.
- If the purpose of the investment is dividends from stocks and the possible profit after selling them, the ROI will compare the ratios of different companies. Comparison often helps to collect an investment portfolio that is more stable to market fluctuations.
The larger the business or company, the more directions require their own payback calculation. And based on the results, the average ROI for the entire business is displayed.
ROI Calculation Examples
As an example, let’s calculate ROI for the Russian stock market and trust management in a PAMM account. From the examples, you can see how to calculate the ROI and how it changes over time or asset value.
ROI for Severstal shares
PJSC Severstal shares pay dividends once a quarter, and for the last year the average dividend amount was RUB 30.5 per share.
Initial financial data:
- In early January, the cost of one share was 940 rubles. This is the size of our investment.
- In July, shares went up to 1074.5 rubles, plus dividends were paid in May and June – 32.08 and 35.43 rubles.
- Then the share price began to fall, and at the beginning of December one share was already worth 884.2 rubles. Plus, dividends were paid in September and December – 26.72 and 27.47 rubles.
By buying one share of the company and selling it in July, we would receive the following return on investment ratio: net income (1074.5 – 940) + dividends (32.08 + 35.43) equal to 202 rubles. We divide by investments of 940 rubles, multiply by 100 and get an ROI of 21.5%.
However, for December we get a completely different picture. Net income (884.2 – 940) + dividends (32.08 + 35.43 + 26.72 + 27.47) is equal to 65.9 rubles. We divide by investments of 940 rubles, multiply by 100 and get an ROI of 7%.
If the payback ratio is much higher than the interest on bank deposits, the prospects for investing in this company look attractive. Of course, taking into account the fact that the company’s shares will continue to grow or bring dividends.
If it is lower or equal to the interest on bank deposits, then further investment in the company’s shares does not make sense.
And also pay attention to the price chart. At one point, the ROI of our investment was 1% (October low on the chart). As you can see, the company’s policy, thanks to the payment of dividends, helped to ensure that the ROI did not become negative.
ROI for Cleveland-Cliffs shares (calculation for 100 shares)
Consider a foreign coal company that also pays dividends on a quarterly basis. The cost of one share is not high, and the minimum investment threshold starts from 100 shares.
Initial financial data:
- In January, the value of one share was $ 7.5.
- In July, the shares “rose” to $ 11, plus dividends (January, April and July) at $ 0.05, 0.05 and 0.06.
- Then the stock began to fall, and at the end of October its value was $ 7. Plus the October dividend of $ 0.10.
Investing in January and selling shares in July, we get the following ratio: net income (11 – 7.5) + dividends (0.05 + 0.05 + 0.06) is equal to $ 3.66. Divide $ 7.5 by the initial cost, multiply by 100 and get an ROI of 48.8%.
A good indicator. But as you can see on the chart, at the end of October we will get a negative ROI of -3.2%.
From the above examples, we can conclude that the ROI value does not change from the amount of investment. The tool gives a clear “picture” for any company.
ROI indicator for investments in PAMM accounts
Today the topic of trust management has found its implementation in the PAMM service. For our calculation, let’s refer to the Moriarti PAMM account. It has been in existence for five years now, and its yield is over 125,000% all the time.
For simplicity of calculation, we will take the minimum investment amount with the maximum percentage of the manager’s remuneration.
Initial financial data:
- The investment is $ 50.
- Manager’s remuneration for profitable trading 40%.
- The profit for the investment period of 1 year was 119%.
Taking into account the commission of 2.5% for the replenishment and withdrawal of capital (it varies for different brokers), we will get the following calculation. Net profit for the period ($ 60.2 – 40% remuneration, minus 2.5% commission) will be $ 35.2. We divide it by the size of the investment, multiply it by 100 and get an ROI of 70.4%.
The return on investment in PAMM is high. But if we look at the statistics, we will notice that during the year such profitability was not always. ROI changed depending on the profitability of the PAMM account.
And also do not forget, if there was a distribution of funds between investors, then we will receive reinvestment of profits. This means that the ROI calculation should be considered at the end of the next payout period. This distribution allows you to get more profit on invested capital (ROI = 73.5%).
ROI calculation for an investment portfolio
An investment portfolio may include several assets of different directions. But most often they use an asset of a certain financial market. As an option, the portfolio can contain stocks, currency and even PAMM accounts.
Let’s deduce the average ROI at the end of the year for the stock and PAMM account from our example. To do this, add three coefficients: PJSC Severstal = 7%, Cleveland-Cliffs = 10%, PAMM score 70.4% and we get the average ROI = 29.13%.
The calculated return on investment can be obtained by distributing capital according to shares. And this, in turn, protects the portfolio for long-term investment.
ROI specifics in different investment directions
If we invest in business, then we must understand that an accurate calculation of the payback ratio is not always possible. After all, what is ROI in business? This is, first of all, accounting for all expenses, but not every accountant can provide such data. And the more complex the line of business, the more difficult it is to account for all costs and investments.
The main directions in which the application ROI most efficiently:
- Direct sale of goods and services through shops, catalogs or email newsletters.
- Loyalty program – allows you to calculate the ROI for each client.
- Sales promotion, through rates of return on investment in marketing ventures.
In other cases, additional analysis tools will be required.
If we invest in securities or invest. portfolios, then we need to take into account the volatility of financial markets. A good ROI will vary from case to case.
What indicator ROI considered good?
- For business, values above 10% are considered optimal. If the ROI is lower, it is more profitable to invest in a bank deposit.
- If we forecast investments for the stock or foreign exchange market, then ROI with a negative value is also acceptable. Moreover, most investors (for example, Warren Buffett) invest in undervalued assets.
- As far as marketing is concerned, the ROI should be above 100%. Since advertising costs must be returned in full, and everything that is higher is already the company’s profit.
By the way, you can calculate the coefficient in the ROI calculator. Online services mainly offer an ROI calculator for marketing investments, but there are also specialized services (both paid and free) with a full set of indicators.
When ROI doesn’t work
The main problem arises when ROI is used as a management tool. But it is impossible to assign a task to the executor through it. ROI is primarily an analytics tool. It is used to determine the statistical reliability of payback, any other interpretation can lead to a loss of investment.
Another problem that negates the ROI efficiency is incorrect (incomplete) calculation of the coefficient. You cannot calculate ROI based on balance sheet or turnover, and even after deducting taxes or other indicators. The calculation is based on the net profit (for a certain period) divided by investments (all investments that were made during the billing period).
ROI advantages and disadvantages
While ROI is easy to use to measure investment performance, it doesn’t have many advantages over other tools.
- Simple comparison of investment assets. The payback rates of several companies make it possible to evenly distribute the shares of capital in the investment. portfolios.
- The ideal solution for a quick assessment of a business or company.
- Shows how correct the investment decision was.
As for the disadvantages, they are most pronounced when calculating the coefficient for complex markets.
- The time factor is not included in the calculation. For some assets, this is a critical parameter.
- All investments and costs are not included. This is often simply impossible to do, especially in large companies.
- Not useful in difficult markets. Where there is no defined rate of return, average check, and short sales cycle, ROI is ineffective.
- Gives an assessment only after the fact. The statistics of future profits based on such data contains errors.
In order to compensate for the shortcomings of ROI, its indicators are compared with those of two more popular tools.
What indicators are calculated along with ROI
For completeness, the ROE and ROA tools should be mentioned. Their indicators allow you to more accurately determine the profitability of the business and the prospects for investments.
Effect of coefficients on accuracy ROI:
- ROE Ratio – allows you to identify the return on equity of the company for the entire time. In addition to ROI, it helps determine the long-term stability of the company.
- ROA – shows the return on equity of the company for the last year. In relation to ROE, the ratio shows the fluctuation in profitability and allows you to assess the stability of the company.
The instruments are only used to evaluate companies or businesses.
ROI is a popular topic today, especially among marketers. But often its indicators are adjusted to specific goals. Therefore, try to remain sober before investing in various assets or businesses.
Use additional analysis tools, and then your investments will generate income for a very long time.