Return on Investment (ROI) is a financial metric used to measure the profitability or efficiency of an investment. It is a widely used financial metric that helps assess the likelihood of gaining a return from an investment.
It is simple yet effective tool that provides either an absolute ratio (e.g., 0.50) or a percentage value (e.g., 50%). This makes it useful for comparing different investment opportunities or multiple trading operations.
At its core, ROI evaluates the return on an investment relative to its initial cost. The formula is net profit divided by the net cost. To express ROI as a percentage, the result is multiplied by 100.
A positive ROI signifies a profitable investment, while a negative ROI indicates a loss.
As an example, if one buys an item for $100 and its value increases to $150, they can then sell it. The ROI is calculated as: (150 - 100) / 100 x 100 = 50%.
This means the investment yielded a 50% return.
ROI is important because it helps investors and businesses measure the profitability of an investment and compare different opportunities. However, it has limitations as it does not account for time, risk, or additional costs, which can affect the actual return.
Therefore, while ROI is a useful tool, it should be used alongside other financial metrics for better decision-making.
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