Return On Investment

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Definition: Return On Investment


Return On Investment

Quick Summary of Return On Investment


ROI (Return on Investment) is the premium an investor receives for investing in a company when he liquidates his holdings. Private equity investors express their return expectations in terms of percentages, much the same way lenders price their loans. By determining what compounded annual rate of return he wants from a given investment, an equity investor can then work with his projections for the company’s growth to arrive at the percentage of the company’s stock he needs to receive in order to reach his desired return



Video Guide For Return On Investment




Full Definition of Return On Investment


Return on investment (ROI) 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.

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, the 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 curve-fitting 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.

What ROIs do most venture capitalists require to fund a company? They vary from company to company. The following chart gives some general ranges, based on an economy supporting prime interest rates below 10 percent.

Company Stage
Compounded Annual ROI
Seed or start-up 35% and up
First and second stage 20% to 50%
Third stage and mezzanine 15% to 30%

 How these rates of return translate into cost to a company depends in large part on how long it takes the investor to exit. The following table illustrates this fact.


Payoff
Compounded
Annual ROI
Three times investment in three years 44%
Five times investment in three years 71%
Seven times investment in three years  91%
Four times investment in four years 41%
Three times investment in five years 25%
Five times investment in five years 38%
Seven times investment in five years 47%
Ten times investment in five years 58%

Synonyms For Return On Investment


ROI


Related Phrases


Compound interest formula
Curvefitting
Depletion
Depreciation
Distributions
Dividends
Fiscal year
Fixed income investments
Least squares
Mutual fund
Profits
Regression analysis
Slope


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Definition Sources


Definitions for Return On Investment are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 29th November, 2021 | 0 Views.