Even the best stock sites offering investment advice cannot show you how much your investment would be worth in 25 years or so if you have no idea how to calculate the rate of return on stocks. It would also help if you learned the factors that influence stock returns so you can estimate your future stock values.
What's the Stock Rate of Return?
Rate of return (ROR) refers to the income an investment brings during a specified period, usually each year, which is calculated as a proportion of the original investment. It is usually expressed as a percentage and could be either a gain (positive) or loss (negative). And it offers a more accurate view of how securities perform since they tend to have different values.
Therefore, the rate of return on stocks is the income your stocks bring annually compared to the original investment you put in when acquiring them.
The standard rate of return formula is:
ROR = (Final Investment Value-Original Investment Value/Original Investment Value) X100 percent
However, it is crucial to understand the difference between stocks and shares even if some people tend to use them interchangeably. You will need that knowledge when calculating ROR.
Generally, shares represent the smallest complete unit of an individual company that you can own. On the other hand, a stock is the total equity or ownership slice you can own in each company you invest in. So, your company stock is made up of a specific number of shares you accumulate over time. Also remember that stocks tend to refer to publicly traded companies, while shares refer to individual company ownership units.
For example, if you say you own 20 shares, someone would expect you to specify the company whose shares you own. However, if you say you own 20 stocks, someone would expect you to mention the 20 different companies you have bought shares in.
Factors Affecting Stock ROR
Some of the factors that affect the result you will get after using the stock rate of return formula include:
- The total dividends paid for the year
- The number of shares you own in a company stock
- The current market value of the company shares
- The original purchase price of the shares you own
Calculate Rate of Return on Stock
The procedure below will help you calculate the rate of return on stocks. Do bear in mind that the numbers are arbitrary and may not reflect average rates of return in reality.
- Suppose you want to calculate the rate of return on a stock belonging to company ABC for the past five years. In that case, you need to find the original price of the shares you acquired over the years and add them up. If you have the original receipt, you can refer to it. But you can also refer to your brokerage account statement or find the information online based on when you bought the shares.
- Once you determine how many shares you bought at specific prices, you can calculate the total. For example, if you originally bought 100 shares of company ABC at $1.50 during an economic downturn and a second batch of 500 shares at $2.50 shortly after, your total original investment value is (100 x 1.5) + (500 x 2.5), which is $1,400.
- To determine the current value of your investment, find out the current market value of each company ABC share (which could be the value at which you just sold the shares) and multiply it by the total number of shares. Suppose your company stock is currently valued at $11 per share after five years. In that case, that would be a total of 600 shares multiplied by 11 for a final investment value of $6,600.
- If you have never received any dividends, you can calculate the ROR at this point. And it would be ((6,600 - 1,400)/1400) x 100 percent, which is equal to a gain of 371 percent over the past five years, and an average rate of return of 74 percent per year.
- However, if you have received dividends, the result could change. Suppose you received dividends of $60 per year for the past three years, which would be an additional $180. In that case, you should add the amount to the final investment value for a new total of $6,780. When you divide this number by $1,400 and multiply it by 100 percent, your new ROR would be 484.29 percent over five years and an average of $96.86 per year.
It pays to learn the basics concerning stocks, such as calculating the rate of return. That way, you can estimate how it will perform in the future. Also, you can use such calculations to determine whether your investments have made or lost money over a specified period. And that will help you decide whether to hold them or dump them.
- IG: Rate of return definition
- Corporate Finance Institute: What is a Rate of Return?
- The Street: Stocks vs. Shares: What’s the Difference?
- Finance Formulas. Net: Total Stock Return
- Taxes for Expats: I’ve Sold Stock but Don’t Know the Original Purchase Price of the Shares. How Could I Report the Cost Basis for the Transaction?
I have been a freelance writer since 2011. When I am not writing, I enjoy reading, watching cooking and lifestyle shows, and fantasizing about world travels.