ROI stands for Return on Investment and is one of the simplest and most versatile ratios to compare the profitability of investments.

The formula to calculate ROI is the profit made on an investment divided by its cost.

ROI = (sale price - cost) / cost

ROI = profit / cost

For example, if Bendigo invests $500 in Penrith Ltd shares and sells them a year later for $600 (a profit of $100), the ROI from the investment is 20%. That is, $100 / $500.

The ROI of an investment can be compared to other potential investments to determine the best way to invest the money.

However, the ROI has a number of shortcomings, including:

  • It does not factor the time it takes to make the return
  • It does not consider intermediate costs (e.g. brokerage) or benefits (e.g. dividends)

Test Your Knowledge

Harry buys Gryffindor shares for $30 and sells them a year later for $45. What is Harry's ROI?

Harry's gain on the investment is $15. His cost base is $30. Therefore, his ROI was $15 / $30 = 50%.