A:

Determining the investment returns on a stock holding may seem like a fairly simple process, but it can be confusing if you fail to break it down into the proper steps. Stock trades generate dollar profits and/or losses, which are measured in percentages.

Finding the Gain/Loss

In order to find the net gain or loss, subtract the purchase price from the current price and divide the difference by the purchase price of the stock. 

Let's use a simple example to illustrate:

Suppose an investor buys 100 shares of Cory's Tequila Company (CTC) at $10/share for a total investment of $1,000. Now, suppose that two months later the investor sells the 100 CTC shares for $17/share. They receive $1,700, and their profit for the trade is $700.

A profit of $700, however, means very little to an investor, unless they know how large of an investment was required to earn that $700. For example, suppose the investor had also bought 1,000 shares in Rob's Sake Distillers (RSD) at $10 apiece (for a total investment of $10,000), and later sold the 1,000 shares at $10.70 each per share for a total of $10,700. With this trade, they would have profited by $700, yet it took ten times the investment compared to CTC to earn it.

Calculating Investment Returns

To avoid this sort of profit ambiguity, investment returns are expressed in percentages. The CTC investment was made at $10/share and sold at $17/share. The per share gain is $7 ($17 - $10). Thus, your percentage return on your $10/share investment is 70% ($7 gain / $10 cost).

This 70% return would be the same if they had invested in 100 shares or 100,000 shares, provided all the shares were bought at $10 and then sold at $17. By multiplying the percentage return on the investment (70%) by the total dollar amount invested, investors will know how much in dollar terms they have made on this investment (70% return on $1,000 is $1,700; providing a dollar gain of $700).

Using this method, your RSD investment would have yielded only a 7% return ($0.70 gain / $10 cost). So, even though your RSD gain of $700 (7% x $10,000) is equal to your CTC gain, clearly CTC's return is much higher at 70% compared to 7% for RSD.

(Now that you understand how to measure stock investment profits and losses, learn how setting pre-determined limits on your profits and losses can improve your investment performance by reading The Importance of a Profit/Loss Plan.)

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