What is 'Average Return'
Average return is the simple mathematical average of a series of returns generated over a period of time. An average return is calculated the same way a simple average is calculated for any set of numbers; the numbers are added together into a single sum, and then the sum is divided by the count of the numbers in the set. There are many return measures; two of the most popular are return on assets (ROA) and return on equity (ROE).
BREAKING DOWN 'Average Return'One example of average return is the simple mathematical average. For example, suppose an investment returns the following annual returns over a period of five full years: 10%, 15%, 10%, 0% and 5%. To calculate the average return for the investment over this five-year period, the five annual returns are added together and then divided by 5. This produces an annual average return of 8%.
In business, there are three main ways to calculate return. One way is with a simple growth formula, where the return on the investment is a function of growth. The other two measures of return, ROA and ROE, focus on performance rather than growth.
Return From Growth
The simple growth rate is a function of past and present values. It is calculated by subtracting the past value from the present value and then dividing by the past value. The formula is: (Present - Past) / Past.
For example, if you invest $10,000 in a company and the stock price increases from $50 to $100, the return can be calculated by taking the difference between $100 and $50 and then dividing by $50. The answer is 100%, which means you now have $20,000.
Average Return on Assets and Return on Equity
ROA, also referred to as return on average assets and return on investment (ROI), is a function of profit margin and asset turnover. The rate of return on assets is both a profitability and efficiency measure. ROA is calculated by dividing net income by average total assets. For example, assume the net income of company A grows from $1 million to $2 million, while assets grow from $10 million to $100 million. Using the basic growth formula we know that net income grew by 100%, while assets grew by 1000%. This may sound great, but the return on assets is only 3.6%.
ROE is calculated by dividing net income by shareholders' equity. It measures asset efficiency and the degree to which the company is using debt to pay for assets. For example, if company A has stockholders' equity of $1 million one year and $10 million the next, it means ROE is calculated by dividing $2 million by the average of $1 million and $10 million, or $5.5. The answer is 36%.