Return on Investment: Definition, Formula & Example

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  • 0:02 ROI Defined
  • 0:27 Basic ROI Formula & Example
  • 1:54 Formula for Shareholders
  • 2:57 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley

Shawn has a masters of public administration, JD, and a BA in political science.

Return on investment is a crucial analytical tool used by both businesses and investors. In this lesson, you'll learn the basic formula, discover a variant used for shareholders, and be provided examples.

ROI Defined

Return on investment (ROI) is the ratio of a profit or loss made in a fiscal year expressed in terms of an investment. It is expressed in terms of a percentage of increase or decrease in the value of the investment during the year in question. For example, if you invested $100 in a share of stock and its value rises to $110 by the end of the fiscal year, the return on the investment is a healthy 10%, assuming no dividends were paid.

Basic ROI Formula and Example

The basic ROI formula is: Net Profit / Total Investment * 100 = ROI. Let's apply the formula with the help of an example.

You are a house flipper. You purchased a house at the courthouse auction for $75,000 and spent $35,000 in renovations. After sales, expenses, and commission, you netted $160,000 on the sale of the renovated house. What is the ROI?

Your net profit is going to be what you netted ($160,000) minus what you spent ($75,000 + $35,000), so it is $50,000. Your total investment is also what you spent ($75,000 + $35,000), which is $110,000.

ROI = Net Profit / Total Investment * 100

ROI = 50,000 / 110,000 * 100

ROI = .45 * 100

ROI = 45%

If only house flipping was that easy. Keep in mind that you can certainly lose money on an investment. If there is a loss, the formula will yield a negative number. Here's a simple example:

ROI = -1,000 / 5,000 * 100

ROI = -0.2 * 100

ROI = -20%

Formula for Shareholders and Example

Shareholders can calculate the value of their stock investment in a particular company by use of this formula: ROI = (Net income + (Current Value - Original Value)) / Original Value * 100.

Let's say you have stock in a tech company. You originally purchased the shares for $5,000 and they're now worth $5,200. You've also been paid $75 in dividends. What is your ROI for this stock holding?

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