Return on investment on invested capital is determined in several ways, depending on the basis of measurement. Capital can be invested in the real sector of the economy or in the financial sector.
Many investors simultaneously invest in assets of the real sector of the economy and financial instruments. The tool for analyzing the profitability of such investments are indicators:
The return on investment ratio shows the return on capital invested in the business at the current moment and is regularly assessed in the course of the activity of the invested object.
It is defined as the ratio of the difference in income minus production costs to the total investment in the business as a percentage.
Full business investment includes equity and long-term liabilities of the investee:
Where:
This indicator reflects the effectiveness of investment capital management, according to which the investor evaluates the work of the management of the invested object. A positive performance assessment occurs when ROI > 100%, which means that the investment has paid off and is making a profit. The size of this profit and the dynamics of its change serve as an assessment of the effectiveness of the company's activities.
For example:
Then ROI, in accordance with formula (1), at the beginning and end of the year will be: 40% and 50%, i.e. the return on investment ratio increased by 10%, which indicates the high efficiency of the company's management.
Another indicator of return on investment on invested capital is the ROIC (Return On Invested Capital) indicator - translated from English as “return on invested capital”, and in fact, the return on invested capital.
It is defined as the ratio of net profit to the capital invested in the main activity of the investee.
In Russian economic terminology, this is an indicator of the return on investment, but only those that are invested in core activities, that is, the return on investment in fixed assets. Fixed capital in this case means fixed assets plus net other assets with the amount of working capital for the main activity. A prerequisite for calculating this indicator is that the net profit created only by the capital that is in the denominator of this indicator is taken into account. Sometimes, in case of difficulty in isolating total cost fixed capital and the determination of the profit created by it, they resort to a simplified calculation, dividing all profit by the cost of capital. If the size of non-fixed assets is small, then the error of the indicator will be small and acceptable for analysis, but if this is not the case, then such an indicator cannot be trusted.
This indicator demonstrates to the investor the ability of the management of the investee to generate added value in comparison with other investee objects of the investor. For such assessments, a certain standard is used - the rate of return on investment in a competitive environment.
The rate of return on an investment is the ratio of the return received to the investment that generated that return in percentage terms over a specific period of time.
For example, an investor has three investable objects:
Accordingly, ROIC at the beginning and end of the year:
Accordingly, the rate of return is:
If the investor considers the minimum allowable rate of return per 1 ruble of investment to be 10%, then 1 and 2 investment objects do not meet this requirement and the reasons for such a low investment return should be analyzed, and for the second object, an additional analysis of the decrease in investment return is required. If it is impossible to increase the profitability of 1 and 2 investment objects, the investor raises the issue of closing the investment project.
If the analysis of the return on investment is carried out over several years, then cash flows are discounted by the time the profitability is analyzed at the discount rate adopted by the investor.
The disadvantage of this indicator is that management is focused on "squeezing" profits from investments in any way at the current moment, which can lead to a lag in the renewal of production and ultimately lead to a loss of the company's competitiveness.
Return on investment on invested capital in financial assets consists of current and capitalized components.
Current income is defined as the difference between the selling price received at the end of the investment period and the purchase price of the security.
I = St - So
For example, an investor purchased 10 shares at a price of 1,000 rubles at the beginning of the year, and at the end of the year, his income from the sale of shares amounted to 11,500 rubles. In this case = 11,500 - 10,000 = 1,500 rubles.
The ratio of current income to invested investments is called the capital gain or interest rate and is expressed by the following formula:
Where rt is the interest rate, and for this investment it is 15%.
Another indicator for evaluating the return on invested financial capital is called the relative discount. It is defined as the ratio of current income to income at the end of the period:
Or for our example: dt = 1500 / 11500 * 100 = 13%.
This indicator is also called the discount factor. The interest rate is always greater than the relative discount.
The total return reflects the increase in invested capital for a defined period, taking into account the redemption of the security.
The main indicator used in the analysis of total return is yield to maturity YTM, which is akin to the internal rate of return on an investment, IRR, is the average effective interest rate at which the value of all income received is discounted to the value of the initial investment. Like IRR, this indicator is rather complicated to calculate, but the formula for a simplified calculation of this indicator is presented below:
For example, purchased 10 shares for 10,000 rubles bring annual income:
The capitalization of 10 shares by the end of 3 years amounted to 1,500 rubles:
YTM = 4500+(11500-10000)/3/(11500+10000)/2= 46.5%
Obviously, the yield to maturity is significantly higher interest rate, which allows us to assert the expediency of these investments in a financial instrument.
In order to choose the most promising among the huge number of investment options on the Internet, investors need universal evaluation criteria. The most obvious one is profitability, a measure of the increase or decrease in the amount of investment over time.
Profitability is measured as a percentage and shows the ratio of profit from to the amount of money invested. It shows not how much specifically the investor has earned, but the effectiveness of investments. When analyzing investment options, investors look at profitability in the first place, often forgetting about possible ones.
I would not write a long article if one formula worked for all cases - there are enough pitfalls when calculating profitability in different cases. In principle, you can not bother and use it for these purposes, but it is still desirable to understand the essence of the issue.
The article talks about common situations related to the return on investment. There will be a lot of 8th grade math, so get ready ;) Happy reading! Content:
The basic formula for return on investment looks like this:
Investment amount is the initial investment amount plus additional investments (“topping up”). Investment profit may consist of the difference between the purchase and sale price of an asset or the net profit of an investment project. It may also include regular payments for (for example, stock dividends).
If the profit is unknown, but you know initial investment amount and current balance(the amounts of buying and selling an asset are also suitable) - use this formula:
Return on investment measured as a percentage and can serve as a reliable benchmark for comparing the two investment projects. The following example looks very illustrative:
Project A - $1,000 profit per year with an initial investment of $5,000. Yield — 1000$/5000$ = 20%
Project B - $1000 profit per year with an initial investment of $2000. Yield — 1000$/2000$ = 50%
Obviously, project B is more profitable, since it gives more high return on investment, despite the fact that the net profit of the investor is the same - $ 1000. If you increase the amount of investment in project B to $5,000, with a yield of 50% per year, the investor will already earn $2,500.
That is, the profitability clearly shows in which project, other things being equal, the investor will earn more. Therefore, an investor with a limited investment portfolio tries to pick up assets with a higher yield.
In practice, there are often situations when investments work many periods in a row- simple interest (profit is withdrawn after each period) or compound interest (profit) begin to work.
A task that is more relevant for active web investors is that they can shuffle their investment portfolio even more than once a week.
For starters, what is inputs and conclusions? This is any change to the initial investment capital that is not related to profit or loss. The simplest example is the monthly replenishment of the investment account from the salary.
Each time you deposit or withdraw funds, the denominator of our yield formula changes - the amount of investments. To calculate the exact return on investments, you need to know the weighted average size of investments, calculate the return on investment, taking into account inputs / outputs, and thus calculate the return. Let's start with profit, the formula will be:
All transactions for investment accounts are usually recorded in a special section like "Payment History" or "Transfer History".
How to find out weighted average investment? You need to break the entire investment period into parts, divided by input and output operations. And use the formula:
The Word does not really want to obey and the formula turned out to be clumsy in appearance. Let me explain it on my fingers - we consider the “working” amount of investments in each of the periods between input and output operations and multiply it by the length of the period (in days / weeks / months) that this amount has worked. After that, add everything up and divide by the total length of the period that interests you.
Let's now see how it works with an example:
The investor has invested $1000 in an investment instrument. After 4 months, the investor decided to add another $300. After another 6 months, the investor needed money, he withdrew $200. At the end of the year, the investment account reached $1,500. What is the profitability of the investment instrument?
Step 1 - calculate the received investment profit:
Profit = ($1500 + $200) - ($1000 + $300) = $400
Step 2 - calculate the weighted average size of investments:
Investment amount = (4*1000$ + 6*(1000$+300$) + 2*(1000$+300$-200$))/12 = (4000$+7800$+2200$)/12 = 1166.67$
Step 3 - calculate the profitability:
Yield = (400$/1166.67$) * 100% = 0.3429 * 100% = 34.29%
And not 50% if we ignored deposits and withdrawals - ($1500 -$1000)/$1000 * 100% = 50%.
Since the yield of many investment instruments is constantly changing, it is convenient to use some average indicator. allows you to bring fluctuations in profitability to one small number, which is convenient to use for further analysis and comparison with other investment options.
There are two ways to calculate the average return. The first one - by formula compound interest , where we have the amount of the initial investment, the profit received during this time, and we also know the number of investment periods:
The initial investment amount is $5,000. The yield for 12 months was 30% (immediately in the mind we transfer $ 5000 * 30% = $ 1500). What is the average monthly profitability of the project?
Substitute in the formula:
Average Return = (((6500/5000)^1/12) - 1) * 100% = ((1.3^1/12) - 1) * 100% = (1.0221 - 1) * 100% = 0.0221 * 100% = 2.21%
The second method is closer to reality - there are returns for several identical periods, you need to calculate the average. Formula:
The project in the first quarter brought a 10% yield, in the second 20%, in the third -5%, in the fourth 15%. Find out the average profit per quarter.
We substitute:
Average return = (((10%+1)*(20%+1)*(-5%+1)*(15%+1))^(1/4) - 1) * 100% = ((1.1 *1.2*0.95*1.15)^(1/4) - 1) * 100% = (1.0958 - 1) * 100% = 0.0958 * 100% = 9.58%
One of the special cases of calculating the average return is the definition percent per annum that we encounter at every turn in the form of advertising bank deposits. Knowing the return on investment for a certain period, we can calculate the annual return using the following formula:
The investor invested $20,000 and earned $2,700 profit in 5 months (round up to 150 days). How much is this in percentage per annum? We substitute:
Yield = ($2700/$20000 * 365/150) * 100% = (0.135 * 2.4333) * 100% = 0.3285 * 100% = 32.85% per annum
The higher the yield, the better, it seems to be obvious. This rule would work well for risk-free assets, but those just don't exist. There is always the possibility of losing part or all of the investment - such is their nature.
Higher returns are much more often achieved through additional increase in risks than due to the higher quality of the instrument itself. This is confirmed by real data - when I conducted Alpari companies, I found a strong relationship between the risk indicator SKO(standard deviation) and return per year:
The x-axis is the return for the year, the y-axis is the standard deviation. The trend line shows that the higher the annual return, the higher the risks of the PAMM account in the form of a TSE indicator.
Yield chart is an indispensable tool for analyzing investment options. It allows you to look not only at the overall result of investments, but also evaluate what is happening in the interval between the events “investing money” and “withdrawing profits”.
There are several types of yield charts. Most often found cumulative yield chart- it shows how much the initial deposit would grow in %, based on returns over several time periods or by results of individual transactions.
This is what the cumulative yield curve looks like:
solandr
It can be used to understand several important things - for example, whether profits grow evenly (the smoother the chart, the better), how big drawdowns (that is, unfixed losses in the investment process) an investor can expect, etc.
I wrote in great detail about the analysis of yield charts in an article about.
Also often used yield charts by week or month:
Chart of the net return of the Stability Dual Turbo PAMM account investor by months
The columns speak for themselves - March was successful, but for the last three months there was no profit at all. If you look only at this chart and do not take into account the older Stability accounts, then you can conclude that the trading system failed and stopped making a profit. A smart strategy in this case would be to withdraw money and wait until the situation returns to normal.
In general, yield charts and PAMM accounts are a separate interesting story.
Let's start with the most obvious - PAMM account profitability charts for all brokers do not correspond to the real profitability of the investor! What we see is the profitability of the PAMM account, that is, the entire amount of investments, including manager's money, and management fee.
When we see numbers like this:
600% in a year and a half, the hand immediately reaches for the "Invest" button, right! However, if we take into account the 29% commission of the manager, then the real return will be as follows:
2 times less! I do not argue, 300% in a year and a half also look great, but it is far from 600%.
Well, if you delve into the essence, then the profitability of a PAMM account is calculated as follows:
As a result, we get a very confused formula, which is necessary for high accuracy of calculations. What should you do if you need to calculate the net return of a PAMM account investor? I suggest using the following algorithm:
All you need is to multiply the official PAMM account profitability figures by one minus the manager's commission. And not the final result, but the data from the PAMM-account chart (they can be downloaded in Alpari in a convenient form) and calculated using the profitability formula for several periods.
For clarity, look at the same yield graph, calculated in three ways:
The difference with and without the manager's commission is almost 2 times! According to the simplified algorithm, we got a result of 92%, according to the exact one - 89%. The difference is not significant, but for thousands of percent it will become quite noticeable:
The green circles show the moments when the manager's remuneration is paid, the red circles show the reduction of your shares in the PAMM account. What is a share? It's yours share in PAMM account, your piece of the total profit pie.
For understanding, such a comparison is suitable - shares are a certain number of shares in a PAMM account. For these shares, you receive dividends - a percentage of the company's profits. The number of shares decreases - dividends decrease, respectively, and the return on investment.
Why are shares decreasing? The fact is that initially you get a profit on the entire amount of your investment - as you should. The time comes for the payment of the manager's commission - and it is taken from your amount, your "piece of the pie." The piece became smaller with all the consequences.
What I showed you is not bad, it's how it is. This is how PAMM accounts work, and whether to invest or not, the choice is always yours.
Friends, I understand that the article is quite complicated, so if you have any questions - ask them in the comments, I will try to answer. And do not forget to share the article on social networks, this is the best gratitude to the author:
And finally, a wish: invest in really profitable projects!
(add me to friends
Speaking in previous articles about how passive investing generally wins over active investing - and also mentioning that more than 80% of hedge funds lose to passive investors - I have not yet written in numbers what kind of investor return we are talking about. So in this article we will talk about investment income. Below is a table of profitability of American investors in the period 2004-2013 (i.e., taking into account the global crisis of 2008):
So, we see that passive investment in the American market (S&P500 index) has brought an average of 7.4% per annum over these years. Close to this result came shares of world companies, which gave an average of 6.9%. Bonds almost doubled during this period, yielding 4.6% per annum. And only then, with a noticeably lower result, is the investor's income - only 2.6%. Moreover, the most interesting thing is that according to the rating calculation method, this is not net profitability, but taking into account positions (equity) that were not closed at the time the statistics were collected. For example, it could be a purchased futures, the expiration of which came later than the statistics were collected.
If we take a fully fixed income, then it turns out to be at the level of 0.6% - i.e. such investment income inferior even to inflation! Moreover, according to statistics, not since 2004, but since 1993, the difference will increase even more - the shares of the American market gave an average of 8.2% over this period, and average income the investor was 2.3% (the return on gold was due to a sharp rise in 2001-2011 - however, in fact, gold is a commodity asset, not much different from, for example, wheat. According to Buffett, gold does not produce anything, although it still has its advantages) .
However, passively investing in the US market would yield results like the table below. Those. at detailed consideration it can be seen that the return on investment over a 10-year period over a distance of 80 years could range from -1.2% to 18.30%. Investment income for a 20-year period - respectively from 2.60% to 17.40% instead of the indicated 8.2% in the table above. To stabilize the results (no one wants to be at least a small loss after 10 years, adding to it losses from inflation) and the investment portfolio serves.
But why does the average investor lose about four times the market result (10.5% per annum)? I will try to highlight a number of reasons.
Such an investor (actually a speculator) is confident in his knowledge and believes that he will be able to predict, if not all, then the main ups and downs of the market or selected valuable papers. Maybe he trusts technical analysis, or maybe he actively follows stock news on the Internet or on TV. But the end result in most cases turns against the investor and in the long run consists of a ballast of spent commissions for operations and incorrect decisions taken. Which, as a rule, more than true. According to various studies ( Do Individual Day Traders Make Money? May 2004; The Cross Section of Speculator Skill Evidence from Day Trading, May 2011) no more than 15% of intraday traders make a profit per year - and almost none of those who were lucky could repeat the high profitability next year.
It is human nature to draw conclusions - and try to find a pattern where it is absent. In principle, any random data set can be described by some average curve, which will not reflect the further behavior of the asset. In addition, the investor usually attaches more importance to the data for the latest period. Extrapolating the continuation of growth, he risks quickly being in a drawdown; extrapolating the fall, it may miss a favorable moment for buying assets cheaply.
From psychology it is known that negative events have a stronger influence on a person than positive ones. According to some estimates, to compensate for the negative emotions from the fall of the market, you need twice as many positive ones. In fact, the average investor does not agree to tolerate a drawdown, especially a protracted one. Often this leads to a fear of investing in stocks and excessive conservatism; It helps to overcome this by understanding that the value of a share is ultimately determined not by the behavior of its quotes (random and volatile in a short period), but by the value and condition of the business that the share issuer conducts. The profitability and debt of the company, as well as the return on equity, are the fundamental factors that will lead the patient owner of the stock to the final result.
Although today you can find different methods for determining your tolerance for capital drawdowns, it is quite clear that this term is emotionally dependent and changes with changing market conditions. In real life, conservative investors with growth stock market can buy stocks just as quickly as aggressive ones, and in a sharp fall, the most aggressive investors begin to show amazing prudence and caution. Other factors that influence risk tolerance are gender and age—women and the elderly are more wary of their counterparts.
Below is the performance of various assets since the early 70s (dividends and coupons are reinvested, commissions are not taken into account):
The graph clearly shows that all the assets presented provided investment income above inflation, however, depending on the instrument, it fluctuated widely. So, from 1972 until the mid-1980s - the crisis period in the United States - commodity assets provided noticeably better returns, and since 2000 they have lagged behind American and world stocks. You can track the current movement of assets using the following table:
https://novelinvestor.com/asset-class-returns
It clearly shows that various instruments in different years turned out to be either at the top or at the bottom of the table. Real estate performed best on average, with the S&P500 roughly in the midline. During the crisis years - the early 2000s with the fall of dot-coms and 2008 - bonds that were located at the bottom of the table in a growing market (along with cash) felt very good.
Taking the average return on investments across all instruments (including reinvestment of dividends and excluding commission fees), at the time of writing, we are getting about 6.72% per year, which is almost equal to the average return on global stocks from 2004 to 2013. Excluding cash, the average value for eight instruments will already be 7.38%.
With favorable economic situation, using high-yield bonds and low asset correlation can theoretically get another 1-2% higher. Compare this with the recorded result of 0.6% per year… of course, you need to take into account that in some years (for example, 2002 and 2008) the portfolio can sink quite strongly.
What to do in this case? The answer is simple: rebalance. But if a drawdown of about 40% is uncomfortable for you, then this should be taken into account at the stage of portfolio formation: the table shows that HG Bond has not sagged by more than 2% over the years. But in terms of yield, among other instruments, HG Bond was often at the bottom of the table, confirming the rule: less risk - less profitability. So in this case, get ready for a more modest end result.
When choosing funds in the paragraph above, it is important to take into account one circumstance that affects the return on investment - commissions, which for ETFs can vary from 0.05 to 1%. At first glance, the difference is insignificant, but let's look at a long distance of 30 years. With an average return of about 8% per year, an initial amount of $ 10,000 per year and regular replenishment (by $ 5,000 per year, and this number increases annually by 5%, compensating for inflation) with a commission of 0.25% in 30 years, it will be possible to count on $533,000; with commissions of 0.9% - only for 439,000, i.е. nearly $100,000 less (ten times the amount originally deposited).
The costs are noticeable even in shorter periods. The investment return of all types of US stock and bond funds over 10 years (if we take the period 2003-2013) will be determined not by their composition, but by commissions - low-cost funds in all cases will give a return of about 1-2% per annum higher than their counterparts. Those. the results relate both to the size of the company (large, medium and small firms) and their types (growth, value, mixed type). The same is true for bonds - you can consider high-yield, short-term and medium-term bonds, as well as corporate and government bonds.
Separately, it is worth mentioning the leaders of the industry. Often, an investor, both during the initial compilation of a portfolio and in the process of investing, has a desire to invest in funds that have recently shown the maximum yield, which sometimes jumps up to 20-30% per annum and even higher. These can range from passive funds in a very favorable market situation to active mutual funds. However, researchers since Sharpe (1966) and Jensen (1968) have seen very little evidence that past returns can have any bearing on future returns.
For example, Carhart (1997) announced that there was no evidence of persistent high fund returns after adjusting for Fama's and French's common risk factors. In 2010, a 22-year study showed that it is very difficult for an actively managed fund to consistently outperform a passive index fund. As an example, Manager William Miller's Legg Mason Value Trust has outperformed the S&P 500 stock index for fifteen(!) years in a row, until it lost all the advantage accumulated over the index in three short years.
Such managers are sometimes jokingly or sarcastically called "lucky monkeys", alluding to the famous experiment with the monkey Lukeria, who chose the dart throwers. Consequently, when investing, it is not recommended for an investor to focus on the current high profitability of funds (rather, on the contrary, it is more appropriate to avoid investing in them). Below is a chart from D. Bogle's book The Smart Investor's Guide:
Finally, periodic replenishment of the balance is very important, which can be done, for example, along with rebalancing. Studies have shown that an income level of $10,000 with an annual return of 8% and an increase in the amount of replenishment by 5% per year can achieve almost the same result as an investment level of 4% with an annual increase in the amount of replenishment by 10%:
A competent portfolio approach allows you to increase the yield from 0.6% to an average of 10% per year, i.e. about 15 times. On the plus side, we get passive investment, in which the portfolio needs to be touched only once a year to restore the original balance or minor changes in composition. The downside is the likelihood of a strong drawdown in certain periods, and therefore, it is necessary to proceed from the freezing of invested funds, which make sense to withdraw only in a growing market. However, such an opportunity is only available when investing through a foreign broker - in programs investment insurance the freezing was taken care of by the company itself.
An alternative could be fundamental analysis individual issuers (shares) and investing in them - with many years of experience, you can thus receive income slightly higher than the market. Not much, but it takes a lot of time for analysis and subsequent tracking of the issuer. As a result, even consultants who are well versed in such a tool usually create passive portfolios for their clients, which are much easier to manage.
Any value (including intangible) and financial resources, which he received as a result of maintenance. The type of income depends on the type of investment. The most common type is cash investment. In this case, the income is measured in monetary terms.
The level of income depends on many factors: the interest rate, the conditions for the return of funds, the availability of collateral, the term and amount of investment.
The rate of return is determined depending on how risky the project is considered. The higher the rate, the higher the risks, and vice versa.
The practically risk-free level of return on investment is considered to be the one when investments bring up to 7% of annual profit. A rate of up to 15% refers investments to the medium-risk zone. And high-risk investments can bring from 30% profit per year or more. But the chance of losing all invested capital is very high.
Simple examples would be rent from previously acquired property, leasing services, the same interest on deposits, dividends, etc.
All this is good, but the profitability of investments is formed not only thanks to current receipts. In order to evaluate all the profits received, there is the concept of total income.
Investor's total income called an indicator that includes itself natural increase the value of the investment object plus current receipts from the use of this object.
