Return on Investment (ROI) is a performance metric used to evaluate the financial efficiency of an investment, or to compare the relative efficiency of multiple investments. It measures an investment’s gain or loss relative to the initial investment. ROI is calculated as follows:

ROI = (earnings – cost of investment) / cost of investment * 100%

ROI typically appears as a percentage; for example, investment XYZ has a ROI of 10%. The ROI calculation is the same for every type of investment – whether it’s stocks, real estate, or collectibles. The calculation can be manipulated, however, in terms of how costs and returns are accounted for. For example, real estate investors can use either the cost method or the out-of-pocket method to determine ROI.

Assume a real estate investor buys a house for $150,000, puts $50,000 into it for repairs and renovations, and then sells the property for $250,000. The investor’s equity position in the property is $250,000 – ($150,000 + $50,000) = $50,000. If the investor uses the cost method, the ROI will be calculated by dividing the equity by all costs:

$50,000 / $200,000 *100% = 25% ROI

If the investor instead uses the out-of-pocket method, the ROI will be calculated taking into consideration the down payment amount instead of the purchase price. A 20% down payment on the $150,000 property would be equal to $30,000, and total costs would be limited to this down payment plus the $50,000 for repairs and renovations, or $80,000 total. With the value of the property at $250,000, the investor’s equity position in the property would be $250,000 – ($30,000 + $50,000) = $170,000. The ROI again is calculated by dividing the equity by all costs:

$170,000 / $80,000 *100% = 212% ROI

As the example shows, the ROI for similar investments can vary greatly, depending on how the value is calculated. In these examples, the out-of-pocket method allows the investor to use leverage (by financing the property) to increase the ROI. It would be important, however, to take into consideration the costs associated with the loan, as they will affect the bottom line. It’s also important to stick to one method if more than one investment is being evaluated; otherwise, the results will be misleading.

  1. What is the formula for calculating the debt-to-equity ratio?

    Expressed as a percentage, the debt-to-equity ratio shows the proportion of equity and debt a firm is using to finance its ... Read Full Answer >>
  2. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
  3. How can the price-to-earnings (P/E) ratio mislead investors?

    The price-to-earnings (P/E) ratio is calculated by dividing a company’s stock price per share by its earnings per share (EPS), ... Read Full Answer >>
  4. Is there value in comparing companies from different sectors by using the debt-to-equity ...

    The debt-to-equity ratio is a measure of a company's financial leverage that relates the amount of a firms' debt financing ... Read Full Answer >>
  5. What is considered a high debt-to-equity ratio and what does it say about the company?

    The debt-to-equity ratio is a measure of a company's financial leverage that relates the amount of a firms' debt financing ... Read Full Answer >>
  6. Does working capital measure liquidity?

    Working capital is a commonly used metric, not only for a company’s liquidity but also for its operational efficiency and ... Read Full Answer >>
Related Articles
  1. Economics

    Calculating Long-Term Debt to Total Assets Ratio

    A company’s long-term debt to total assets ratio shows the percentage of its assets that are financed with long-term debt.
  2. Investing

    How Worried Should We Be About China?

    An economic slowdown, a freezing up in trade and plunging markets and currencies are casting a shadow across Asia—and the globe. How worried should we be?
  3. Stock Analysis

    The Biggest Risks of Investing in Netflix Stock

    Examine the current state of Netflix Inc., and learn about three of the major fundamental risks that the company is currently facing.
  4. Stock Analysis

    What Seagate Gains by Acquiring Dot Hill Systems

    Examine the Seagate acquisition of Dot Hill Systems, and learn what Seagate is looking to gain by acquiring Dot Hill's software technology.
  5. Investing

    What is EBITA?

    EBITA measures a company’s full profitability before reducing it by interest, taxes and amortization considerations, and so is useful for calculating a company’s internal efficiency or profitability ...
  6. Investing

    A Look at 6 Leading Female Value Investors

    In an industry still largely predominated by men, we look at 6 leading female value investors working today.
  7. Term

    What Is Financial Performance?

    Financial performance measures a firm’s ability to generate profits through the use of its assets.
  8. Stock Analysis

    The Biggest Risks of Investing in FireEye Stock

    Examine the current state of FireEye, Inc., and learn about some of the biggest risks of investing in this cybersecurity company's stock.
  9. Stock Analysis

    The Biggest Risks of Investing in Gilead Stock

    Examine the current position of Gilead Sciences, Inc., and learn the major risks for investors considering buying Gilead stock.
  10. Investing

    How to Effectively Monitor Your Stock Holdings

    Investors should concentrate on the business, not the stock price.
  1. Qualitative Analysis

    Securities analysis that uses subjective judgment based on nonquantifiable ...
  2. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and ...
  3. Liquidity

    The degree to which an asset or security can be quickly bought ...
  4. Interest Coverage Ratio

    A debt ratio and profitability ratio used to determine how easily ...
  5. Receivables Turnover Ratio

    An accounting measure used to quantify a firm's effectiveness ...
  6. Balance Sheet

    A financial statement that summarizes a company's assets, liabilities ...

You May Also Like

Hot Definitions
  1. Purchasing Power

    The value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing ...
  2. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  3. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  4. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  5. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  6. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!