What to Do
The basic Return on Investment can be found by dividing a company’s net profit (also called net earnings) by the total investment (total debt plus total equity), and multiplying by 100 to arrive at a percentage:
So if net profit is $30 and the total invested is $250, the Return on Investment is:
A more complex variation of Return on Investment is a formula known as the Du Pont formula, which allows a company to break down its Return on Investment into a profit-on-sales component and an asset-efficiency component, and is:
So if net profit after taxes is $30, total assets $250, and sales $500, then:
This formula was developed by the Du Pont Company in the 1920s, and helps to reveal how a company has deployed its assets and controlled its costs, and how it can achieve the same percentage return in different ways.
For stockholders, the variation of the basic Return on Investment formula used by investors is:
So if somebody invests $5,000 in a company and a year later has earned $100 in dividends, while the value of the stock has risen to $5,200, the return on investment would be:
What You Need to Know
Investors can use an alternative Return-on-Investment formula, which is: net income divided by common stock and preference stock equity, plus long-term debt. Meanwhile, it is vital to understand exactly what a return on investment measures, for example assets, equity, or sales. Without this understanding, comparisons may be misleading. A search for “return on investment” on the Internet, for example, harvests sites detailing staff training, e-commerce, advertising and promotions. Be sure to establish whether the net profit figure used is before or after provision for taxes. This is important for making accurate comparisons of Return on Investment.
Where to Learn More
Web Site:
Investopedia: www.investopedia.com
