Detailed explanation of stock return calculation formula: How to determine if your investment is truly profitable?

What Exactly Does Return on Investment (ROI) Measure?

Many investors often get overwhelmed by various profit figures but don’t know how to truly evaluate their investment performance. In fact, this question can be answered with a simple indicator—Return on Investment (ROI).

ROI is a core financial metric that reflects the capital appreciation ability. It is expressed as a percentage and widely used in personal finance decisions, corporate profitability assessments, and comparisons of different investment vehicles. Whether you invest in stocks, real estate, or run a business, ROI helps you intuitively understand whether your investment is worthwhile.

Stock Return Calculation Formula and Derivation

When it comes to calculating stock returns, many think it’s complicated, but the core logic is very straightforward.

Basic formula: ROI (%) = (Net Profit from Investment ÷ Initial Investment) × 100%

Where net profit = investment income - investment cost.

Let’s understand with a simple example: Suppose you buy a stock for 1 million, and later sell it for 1.3 million, then ROI equals (1.3 million - 1 million) ÷ 1 million = 30%.

However, in actual practice, things are often more complex. For example, if you buy 1,000 shares at $10 each, and after a year, the price rises to $12.5 and you sell, receiving $500 in dividends, minus $125 in trading commissions.

The calculations are:

• Total income = sale amount + dividends = (12.5 × 1000) + 500 = $13,000
• Total cost = purchase amount + trading commissions = (10 × 1000) + 125 = $10,125
• Net profit = $13,000 - $10,125 = $2,875
• Stock return = (2,875 ÷ 10,000) × 100% = 28.75%

This example shows us that when calculating stock returns, you can’t just look at the price difference; dividends, transaction costs, and all influencing factors must be included.

Annualized Return: Making Time Factors Return to Normal

A common trap is directly comparing ROI across different periods, which can be misleading.

For example, Project A’s ROI is 100% over 2 years, while Project B’s ROI is 200% over 4 years. If you only look at these numbers, you might choose B, but in reality, A’s investment efficiency is higher.

This is where the concept of annualized return comes in:

Annualized Return( = [)Total Return + 1(^)1/Number of Years( - 1] × 100%

Calculations:

• Project A: [)1 + 1(^)1/2( - 1] × 100% = 41.4%
• Project B: [)2 + 1(^)1/4( - 1] × 100% = 31.6%

As seen, although B’s total return is higher, after annualization, A’s efficiency is clearly better. The annualized return more accurately reflects the actual investment benefit.

ROI in Advertising and E-commerce

Many marketing professionals, when talking about ROI, are actually referring not to the investment return itself but to a similar but distinct metric—ROAS (Return on Ad Spend).

Suppose a product costs $100, sells for $300, and you spend $500 on advertising to sell 10 units.

Using ROI:

• ROI = [300 × 10 - )100 × 10 + 500(] ÷ )100 × 10 + 500( = 100%

Using ROAS:

• ROAS = )300 × 10( ÷ 500 = 600%

The key difference is: ROI measures profit relative to total costs, including all expenses; while ROAS only considers revenue relative to advertising costs, excluding product costs. In practice, marketers often refer to “ad ROI” as ROAS.

Differences Between ROI, ROA, and ROE in Corporate Investment

For corporate investment decisions, three important metrics should be distinguished:

For example: A company has total assets of $1 million, with $500,000 debt and $500,000 equity. It invests $100,000 in a project and earns $200,000 back.

• ROI of the project = ()200 - 100() ÷ 100 = 100%
• Annual net profit = $1.5 million, ROA = 150%
• Shareholder’s ROE = 150 ÷ 50 = 300%

This shows that the same profit yields the highest ROE, which explains why companies often leverage debt.

Sorting and Risk Trade-offs of Different Investment Vehicles

To improve ROI, the most direct way isn’t just optimizing costs but selecting high-ROI investment targets.

Generally, the ranking of returns across investment types is: Crypto and Forex > Stocks > Index Funds and ETFs > Bonds

But behind this ranking lies an unavoidable reality—higher returns usually come with higher risks.

For example, Forex margin trading can yield over 30% annual returns, using two-way trading, leverage, and 24-hour operation. However, due to international market volatility, ordinary investors find it hard to keep up, requiring strong analysis skills and risk tolerance.

Similarly, CFD trading offers low margin requirements and flexible operations. With $10,000, you might only need $2,000 to trade CFDs equivalent to $10,000 in stocks. If you profit $500, ROI reaches 25%, which seems impressive, but volatility risk also multiplies.

Four High-Return Investment Methods Compared

) 1. CFD Trading

CFDs, with their high leverage, are very attractive to technical traders. Margin requirements are often only 20% of the trading amount, allowing investors to control more with less. But losses can also be amplified. When trading CFDs, always choose regulated platforms and set stop-loss strategies.

2. Forex Trading

The largest financial market in the world for daily trading volume. Compared to stocks, forex offers 24-hour trading, higher leverage, and lower entry barriers. However, geopolitical and economic fluctuations can cause sudden and sharp exchange rate movements, requiring strong fundamental analysis and risk management skills.

3. Gold Investment

A traditional safe-haven asset with value preservation and appreciation features. In recent years, gold prices performed well, with an 18.4% increase in 2019. During economic uncertainty, gold often serves as a defensive asset allocation tool.

4. Stock Market

A relatively mature and stable investment channel. For example, the US stock market has an average annual return of over 12% over 200+ years. With reasonable valuation, high dividend yields, and policy support, it is attractive for long-term investors.

Practical Strategies to Increase Investment Return

From the ROI formula, improving returns involves two directions: increasing profits or reducing costs.

In stock investing:

• Prioritize high-dividend stocks to increase holding income
• Choose brokers with low fees or reduce trading frequency to lower transaction costs
• Diversify investments to balance risk and return

When volatility differs significantly among assets (e.g., crypto and stocks), adjusting position sizes can balance risk. If a coin’s volatility ratio to stocks is 7:3, you can reverse the investment ratio to 3:7, achieving similar expected returns with lower risk.

Additionally, consider valuation metrics. If Index A’s current valuation is at the 70th percentile historically, and Index B’s at the 50th percentile, B’s risk is relatively lower, and its potential upside may be greater.

Four Major Pitfalls When Using ROI

Although ROI is simple and easy to use, ignoring its limitations can lead to poor investment decisions.

1. Ignoring the Time Dimension

Suppose project X has an ROI of 25%, and project Y has 15%. At first glance, X seems better, but if X takes 5 years and Y only 1 year, the conclusion is reversed. This is why annualized return exists—it corrects for time bias.

2. High ROI Often Comes with High Risk

Returns are positively correlated with risk. Focusing only on ROI figures and ignoring volatility can cause investors to panic during downturns, leading to forced liquidation and losses. When evaluating investments, risk indicators like volatility and maximum drawdown are equally important.

3. ROI Can Be Overestimated

If some costs are omitted during calculation (e.g., taxes, maintenance, interest in real estate), the ROI will be seriously inflated. Complete and accurate cost accounting is a prerequisite.

4. Ignoring Non-Financial Benefits

ROI only measures financial returns and does not consider social or environmental benefits. To address this, some have developed the concept of “Social Return on Investment” (SROI), which can serve as a supplementary reference for certain projects.

Conclusion

ROI is one of the most important indicators in investment decision-making, but not the only one. When choosing investments, you should consider both ROI and the underlying risks, and make reasonable expectations based on your risk tolerance, capital, and investment horizon. Only then can you pursue high returns while protecting your principal.