Return on Investment (ROI)
Definition of 'Return on Investment (ROI)'
Return on investment, or ROI, measures how profitable an investment is. Companies often use ROI to make decisions about where to invest profits. An investment of the same magnitude that generates more profits is likely to win out over one with less profit.
TheStreet Explains ‘Return on Investment (ROI)’
The formula for ROI is: gain from investment – cost investment/cost of investment. ROI shows how much profit an investment generates as a percentage of the investment cost. Companies use ROI to gauge profitability of separate business segments or of individual assets such as a single machine in a factory line.
Investors also can use ROI to gauge returns from their investments in company shares. This is not the same as a company’s return on equity, or ROE, but a measure of the investment gains relative to cost. Suppose you buy a share in company for $1,500 then sell it for $2000. You ROI would be $500 divided by $1,500 or 33%. Suppose you paid $1,500 for shares in another company and sold that one for $1,700. Your ROI would be just 13%. The first investment appears to be the better choice, assuming both investments were held for the same period of time.
If, however, you held the first investment for three years and the second for just one year, you would have to divide your returns by the number of years held. In this case 33% divided by three years is 11% while 13% divided by one year is still 13%. So the second investment appears to be the better choice under this scenario.
By calculating ROI of different investments, you can make better decisions on where to allocate your money.