Return on Investment
Return on Investment (ROI) is the profit you make when you sell your shares. It includes any income you earn on the investment plus the profit that you make on the sale.
For example, if you paid $10,000 for stock in a company and then sold the stock for $12,500 one year later and received $100 that year in dividends, your ROI would be 26%. To find this number, you add the $2,500 gain to the $100 worth of earned income. Then divide the total ($2,600) by the original investment ($10,000). Finally, convert the decimal by multiplying by 100 to find your annual percentage rate.
It is possible to have a negative ROI, if the sale price plus income is less than the price paid for the stock.
Return on Equity
Return on equity (ROE) is a measure of how well a firm has done at reinvesting capital acquired through operations or from stockholders. In general, a higher rate of return is preferable as it means the firm is able to grow its overall value for the investors at a faster rate. However, when reviewing ROE figures across competing firms you will want to also consider how much leverage the company employs. Firms with higher overall debt levels tend to exhibit higher than normal return on equity at the expense of losing operating flexibility due to a need to maintain the debts incurred. The ratio itself is calculated as follows:
ROE = Net Income / Equity
As a general statement, ROE tells you how many dollars in income have been generated per dollar of equity.
Return on Assets
Return on Assets (ROA) is a measure of return based on the assets of the firm. Much like the calculation for return on equity, the higher the overall number the better the company has done at generating profits based on the assets at the company's disposal. Unlike return on equity figures, the effects of leverage are not displayed in the results. The calculation is as follows:
ROA = Net Income / Assets
As a general statement, ROA tells you how many dollars in income have been generated per dollar in assets.
For the sake of simplicity, the examples in this article do not take into consideration commissions and other transaction fees, tax considerations, or margin requirements, which are factors that may significantly affect the returns of a given strategy. Investors should consult a tax, legal, or financial advisor with questions before entering into any options strategy.
The strategies described in this article are for information purposes only, and their use does not guarantee a profit. None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security. Investors should fully research any security before making an investment decision. Securities are subject to market fluctuation and may lose value.