Investing is a journey where every decision adds to the experience and a new perspective. As the portfolio grows and opportunities expand, having simple tools to evaluate outcomes becomes essential for long-term progress. Such a tool is Return on Investment (ROI).
Return on investment (ROI) gives a structure to the investment process. It helps the investors to understand how their capital performs in the long run or the short run, whatever suits them, by comparing profit against the amount invested. When the ROI is viewed correctly, it provides guidance towards consistency, comparison, and efficient decision-making.
In the discussion ahead, learn how to calculate return on investment (ROI), understand the formula, and apply it across stocks, property, and other assets with more understanding and confidence.
What is ROI (Return on Investment)?
Return on Investment (ROI) is a financial performance metric that measures the profitability of an investment by an investor or a company. In order to measure the profitability, the net profit is divided by the investment costs, whether it is the cost of acquiring it, brokerage fees, or taxes, and expressed as a percentage, which makes it easier to compare the potential investment and the income from it against the costs. When the ROI is higher, it gives an understanding that the investment has performed financially well, while a negative ROI means the investment has turned into a loss.
ROI Formula Explained
The Return on Investment (ROI) measures an investment’s profitability against its cost.
To achieve this, the net profit or returns are calculated first by subtracting the total cost of the investment, including fees, expenses, and the cost of acquiring the investment, from the total income of the investment, for example, the sale value and dividends.
Net profit = Total Income from Investment – Cost of Investment
Then, the net profit is divided by the cost of investment to get the return on investment ratio, and later multiplied by 100 to express it as a percentage.
Return on Investment (ROI) = (Net Profit / Cost of Investment) x 100
Example of ROI Calculation
Let’s assume an investor purchased 1,000 equity shares at ₹160/share during a weak market phase and held them through a full business cycle. Over the next five years, the company’s earnings improved, and valuations were rerated, and the stock’s value reached ₹202/share.
Here’s how the ROI calculation flows:
| Share price | ₹160/share |
| Number of shares bought | 1,000 shares |
| Cost of Investment | ₹1,60,000 |
| Share price (after 5 years) | ₹202 |
| Number of shares sold | 1,000 |
| Total sale proceeds | ₹2,02,000 |
| Net profit | ₹42,000 |
| Total Return on Investment (ROI) | 26.25% |
| Holding period | 5 years |
| Annualised ROI (CAGR) | 4.7% |
Using ROI for Different Investments
The investors usually invest their funds into different assets or securities, and the ROI helps them to measure how each investment has performed, compared to the amount invested. It creates a comparable point to evaluate returns from each asset and time frame.
| Investment type | Using ROI |
| Stocks / mutual funds | The ROI calculation for returns in stocks and mutual funds incorporates the purchase price, current value, dividends received, brokerage fees, and taxes on capital gains |
| Real estate | ROI on real estate investment considers the purchase price, closing costs, rental income, property taxes, insurance, and maintenance expenses |
| Fixed Deposits | ROI on FDs are calculated based on the principal amount, interest earned, and the applicable taxes. |
| Businesses/Companies/Projects | Here, ROI incorporates revenue or any cost savings as net income, compared to the total costs, including R&D, marketing and operational expenses |
Importance of ROI Calculation
- Guides decisions: The ROI highlights which projects, investments, or campaigns are worth investing in, which helps the decision-makers to prioritise profitable initiatives.
- Measure results: It provides a straightforward view of investments performance over time, using numbers instead of assumptions.
- Capital structuring: The companies use ROI to direct funds toward those areas that generate better income and avoid inefficient use of resources.
- Builds investor trust: When the ROI of a company is consistent and transparent, it shows the company’s credibility, which makes it easier to attract fresh capital.
Common Mistakes in ROI Calculation
- Incomplete cost accounting: In some cases, the indirect expenses such as maintenance, training, compliance, or taxes might be overlooked by the investors or companies, which can distort the ROI percentage, showing a misleading figure.
- Mixing revenue with returns: If the gross income or inflows are treated as profit, it will exaggerate the performance and hide the true gain from an investment.
- Short-term view: Companies might only consider short-term results while ignoring early-stage, idle periods, or depreciation, which can impact long-term decisions, especially in property and capital equipment.
- Time-value blind spot: If the discounted future cash flows are ignored, it can make long-duration investments look better on paper than they actually are.
Conclusion
Return on Investment (ROI) is a simple metric, yet an effective way of understanding how an investment performs across different assets. It compares profit against costs, bringing clarity to investment outcomes, and helps in filtering better investment choices for investors and companies. While it does not capture each and every aspect of performance, especially for long-term decisions, ROI still remains a reliable starting point for evaluating performance, capital allocation, and building disciplined investment habits.
FAQ‘s
The ROI is calculated by subtracting the cost of investment from the total income to find the net profit. This profit is then divided by the cost of investment and expressed as a percentage, which shows how much return was generated in comparison to the capital invested.
The ROI formula is calculated by dividing the net profit by the cost of investment and multiplying the result by 100. The net profit is the difference between the total income earned from the investment and the total amount spent while acquiring and holding it.
Yes, the ROI can be negative if the income from the investment is lower than its original cost. A negative ROI indicates a loss in investment and signals that the investment did not generate enough returns to recover the capital invested.
In order to calculate ROI investments in stocks, the purchase price, selling price, dividends received, and transaction costs are considered. The net profit from these is divided by the initial investment amount to determine the overall return percentage.
The ROI helps investors in comparing different investment opportunities using a common measure. It supports better decision-making by highlighting which investments generate better value, which underperform, and how efficiently capital is being used over time.
