The one question which is bombarded by every stock market teacher, investor, or trader, every time they meet someone new. One can’t find what they might be thinking in their heart, but if we go by their words, they are asking- What is your ROI?
So, What Is ROI?
ROI or Return on Investment is a metric with which one can find the gain or loss earned with respect to its initial investment/cost. To put it plainly, it is the gain or loss one has earned with time on the money they have put. It is a percentage return generated on an investment/trading done over a period. Be it a new project, business, or the stock market, ROI is used in evaluating the potential return on investment.
ROI is one of the most important metrics to compute when one conducts a fundamental analysis of stocks. Considering all the factors of fundamental and technical analysis of stocks being equal, investors with better emotional control and more patience, have higher ROIs. On the other hand, investors who panic have lower ROIs.
Examples:
How do you calculate ROI? Let’s understand with some examples:
ROI = * 100
Profit= Final value – Initial value.
Let us consider some basic examples to understand ROI more clearly.
Example1: Abhishek purchased a house for 50 lakhs in 2015. After 5 years, i.e., in 2020, he sold it for 1.2crores. Calculate the return earned by Abhishek over this period.
Solution: To calculate the percentage of return, i.e., ROI:
ROI = * 100
Profit = Current or Final value – Cost of Investment
Here, current value of the asset sold by Abhishek which is 1.2 crores. Hence,
ROI = * 100
= * 100
= * 100
= 1.4*100
= 140%
So, the return on investment in a span of 5 years is 140%. It is important to note that, this return has been generated in a span of 5 years. Hence,
Annual ROI =
Annual ROI = 28%
Hence, it means that the value of the asset, which is home in this case was increasing by 28% every year, on an average without considering the effect of compounding.
This is how we can calculate ROI very easily with the help of MS Excel. To calculate the return earned on stocks, or to do a portfolio health check after a fundamental analysis of stocks, one can employ the same way. For calculating the trading return for a year or more, one can use the simple, yet more advanced formula, XIRR.
Calculating ROI in the stock market:
Let us pick up some stock case studies and calculate their ROI. We know that you’ve been waiting for it.
Disclaimer: These are not investment advice. We would recommend doing your own fundamental analysis of stocks and research before investing.
Stock 1:
Laurus Labs debuted into the secondary market in 2016 December with a stock price of Rs 95. In November 2022, the stock price is somewhere around Rs 477. So, to calculate the ROI of Larus Labs,
Final Value = Rs 477
Initial Value = Rs 95
ROI = 0
= 100 = 4.021100
= 402%
The ROI generated by Laurus labs for a period of 6 years is 402%, whereas a yearly return would be:
Annual ROI = (around)
Example 2:
Let us pick Neogen now. Neogen debuted in May 2019, with a price of Rs 262. The current market price of Neogen as of November 2022 is Rs 1500. So, to calculate the return on investment generated by Neogen,
CMP= Final value = 1500 Rs
Investment value/Initial value = 262 Rs
ROI = 100 = = 4.725100
= 472%
In a span of 3 years, Neogen has generated a whopping 472% return on investment, which makes it an approx.
Annual Return on Investment of 157.3 %.
Example 3:
Stock name: Indigo Paints
Listing date: 5th Feb 2021
Listing price/Initial investment: Rs 2630
Current market price: Rs 1590
ROI = 100 = = -0.395100
= -39.5 %
Here, unlike the above two stocks, Indigo Paints stock has delivered a loss of 39.5%. The negative sign in the ROI represents a loss.
This necessarily doesn’t imply that the fundamentals and techniques of the stock are bad. It implies that the company has given a good return for the period. This metric is highly dependent on the period it is calculated. If the period is changed, it might even happen that the return is different and positive. Although, emphasis is paid to the most recent data. If one’s investing, then one should always look at the past 5-year data of the stock in the market.
This is the harsh reality of stock markets. Even if you find a gold mine, you must enter it at a right time. It is not like you invest in a stock and waiting for a couple of years and then sell as it will always go up. Even the best stocks have a consolidation period that might even continue for a decade. The markets are filled with many good stocks, which have generated no or negative returns in their consolidation period, and later have generated multifold returns. But, to know and master this skill of timing your investments as per the market cycles of the stock, one must have a decent knowledge on the fundamentals and technicals of the stock market, as this topic is not an easy concept to master.
How to do an accurate ROI calculation?
ROI is used to determine the profitability of the company or business. Accurate ROI is calculated by accounting for total returns and total costs incurred. It is vital to note that total costs include all hidden costs too.
Ways to interpret the analyzed data:
After finding out the ROI, a positive ROI indicates a profitable business, whereas, on the other hand, a negative ROI parentage indicates the loss percentage, for the selected period.
Benefits of ROI
1. Comparative Analysis:
Comparisons can be made between various organizations, financial instruments, bonds, asset classes, etc., belonging to the same sector for the same period. Through this metric one can segregate the best performer for the period easily. ROI acts as a great filter to find out the most profitable opportunities.
With the ROI metric, one can even identify the best asset class for themselves, as per their requirement and risk appetite. With the same ROI parameter, one can investigate if the asset class has given the promised return. The ROI concept can be implemented in stocks as well.
For example, from the above stock market example, you can conclude that Neogen proved to be a more profitable investment than Laurus Labs and Laurus labs were wonderfully good when we compared it with Indigo Paints.
- Self-explanatory:
When someone says the Return on investment for Nestle for the past 5 years even before explaining it, most of them can understand what it means. It clearly says the return earned on an investment, which makes it easier even for a layman to understand what you are talking about.
Limitations of ROI:
ROI does have some cons as well which are as follows:
- The time factor hasn’t been accounted for:
It might seem to a beginner that a financial instrument or a stock with a higher ROI is better. But the factor to consider over here is that, while the calculation of ROI, the period of investment is never accounted for. You must do this calculation in the next step. Let us understand this with the help of an example:
Let us take two stocks, namely Stock A and Stock B.
Stock A has given an ROI of 50% whereas Stock B has an ROI of 25%. Can you tell me which one has delivered greater returns?
Is your answer Stock A?
Please don’t conclude it in haste, as
Let’s say, Stock A has given a return of 50% for a period of 5 years, whereas Stock B has given 25% return in a span of 2 years. Now, when calculated annually,
Annual ROI of Stock A= = 5%
Annual ROI of Stock B =
Now, when you observe, you can say that the ROI of Stock B is higher than that of Stock A.
- ROI is different for different businesses:
Since there are several methods of ROI calculation, therefore one might find different values of ROI for the same period and asset. For e.g., a marketing manager might not consider costs such as property taxes, sales fees, legal costs, stamp duties maintenance costs, etc., in the ROI calculation for a property. But an investor will need to add all these costs to find out the true ROI, as for them return is to be calculated with all the hidden costs included. It provides a true return, which further eases decision-making.
Alternatives of ROI
Various alternatives to ROI include:
IRR: Internal Rate of Return, is used to estimate the gain for an investment. Unlike ROI, it considers the timing of cash flows to measure the profitability of an investment. Whether the investments are periodic or aperiodic, the rate of return is obtained through this method. This also eliminates the additional step required for finding out the annual return which is a pivotal metric for venture capitalists and private equity.
Note: IRR tells you the annual rate of growth that an investment is expected to generate, which is unlike ROI.
- ROE / ROA: Return on Equity and Return on Assets are two other frequently used ratios to calculate the return. In contrast to IRR, these ratios don’t consider the timing of cashflows to calculate the annual rate of return. Equity and assets have a definite meaning whereas “investment” can mean different things.
Types of ROI
1. Marketing statistics ROI:
To determine the true effectiveness of a marketing campaign, this ratio is used.
Marketing Statistics ROI = *100
- Social media ROI:
With this ROI, you can measure the success and effectiveness of a social media campaign.
Social Media Statistics ROI = *100
Factors That Affect The ROI
ROI is an important factor in determining the profitability of any business or any product from any industry. If one is unaware of the ROI, they are completely unaware of the potential of the product, campaign, or business. Ineffective business strategies or campaigns can be identified for elimination through a review of ROI calculation.
For e.g., if one’s social media ROI is good, then it means implies that more investment can be made in campaigns. If the social media ROI is low, then you need to identify what is going wrong within the process before investing any more money into the campaign.
The top 5 factors which affect the impact ROI are:
⦁ Top Line: Top Line is none other than revenue. Higher the sales revenue, the higher will be the top line. The higher the top line, the higher will be the possibility of profits.
⦁ Bottom Line: Bottom line denotes profits, especially Profit After Tax (PAT). Higher sales usually result in higher profits. But sometimes the real profits might be very low despite good revenues. This can be due to increased operating expenses, etc.,
Greater Profits = High ROI.
Besides all these, factors like educational impact, engagement, etc., lead to brand awareness which directly impacts the top line and thus the ROI.
Sectors in the stock market with the highest ROI in the past 5 years:
In the past 5 years, Stock market sectors in India with high ROI are:
⦁ With an exceptional ROI of 85%, Nifty Energy sector index tops the chart. The paradigm shift and focus on the usage of a more sustainable source of energy have led to a massive expansion in the renewable energy sources space.
⦁ With growing government initiatives and awareness in the finance sector, Nifty Financial Services, a backbone of the Indian economy, has delivered 76.41% ROI in the past half-decade. Being the favorite pick of both domestic and foreign players, government has released multiple reforms to liberalize, regulate and enhances this industry.
⦁ The FMCG sector, which includes household and personal care, is India’s fourth largest sector. With a growing lifestyle, Nifty FMCG has delivered an ROI of 72.67%.
⦁ The nifty IT index which constitutes the performance of major Indian IT companies has delivered an ROI of 73%.
⦁ The metal sector has been in the limelight for the past couple of years. With India, being the second largest crude producer in the world, Nifty metal has delivered an ROI of 54.27% in the past 5 years.
What is a good ROI in a business?
Since ROI is dynamic in nature, the number for a good ROI varies from industry to industry. Further, it also depends on the advertising channel of your business. Some products or marketing combinations would provide you with a higher ROI than your competitors, and some might not work for you. It’s crucial to know what ROI is normal, what is low, etc., for both your business and campaigns.
⦁ Some industries can have an ROI as high as 10-15%
⦁ Whereas, for other industries, a 1-2% return is good.
ROI for any industry will fluctuate because of evolving techniques, changing consumer tastes, new competitors, etc. During the process of spreading the word about your brand and building brand recognition, etc., a good ROI would be 20-25%. The same is applicable especially to popular advertising channels like PPC (Pay-Per-Click) Google ads, Email marketing ads, etc., Keeping a track of the source of your leads and analyzing them for conversion profits is one effective way of measuring your advertising ROI.
For example, print ads for new products can cost a fortune for company. However, options like social media campaigns and content marketing are much more economical.
Keeping a track of the ROI attached to each type of marketing strategy helps in determining the best cost-effective, high-return options that make a huge positive impact on your company.
ROI is one metric amongst various metrics used in the Fundamental Analysis of Stocks, and fundamental analysis is one branch of Stock Market Courses in India. If you want to learn from scratch and grow till advanced in the field of the stock market, then Goela School of Finance is the top-rated Stock Market Institute in India.
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