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Return on investment

Return on investment is a method of calculating profits from an investment. The gain is converted to a percentage to facilitate uniform comparison. The usual formula is 100 X gain/cost. The number is useful for comparing the performance of investments and resembles the yield paid on fixed income investments like CDs.

Expanded Definition

The time period used for the calculation can vary, but the most common one is for the calendar year or the fiscal year.

When stock investments are compared it is common to calculate the gain as the difference between the closing value for a recent date and the closing value for one year earlier. When dividends have been paid or distributions from a mutual fund, they are added to the gain.

In some cases cost is adjusted by subtracting depreciation or other allowances like depletion.

A negative value is reported when the result is a loss.

When the time period exceeds one year, the compound interest formula can be used to calculate the compounded rate of return for the investment.

When calculations are based on single stock prices, the number can vary wildly depending on the particular times chosen to select stock prices. More reliable estimates can be obtained by averaging prices over a specified period or by using curvefitting techniques such as least squares (regression analysis) to fit a calculated line to a collection of stock prices. Then the slope of the calculated line approximates return on investment.

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