Even the best stock sites offering investment advice cannot show you how much your investment would be worth in a specified number of years if you have no idea how to calculate the rate of return on stocks. It would also be helpful to learn the factors that influence stock returns so you can estimate your future stock values.
What's the Stock Rate of Return?
According to IG International Limited, the rate of return (ROR) refers to the income an investment, such as real estate or stock, brings during a specified period, usually a one-year period, and calculated as a proportion of the original investment.
It is usually expressed as a percentage, which could be either a gain (positive) or loss (negative). Plus, the total return after a specified holding period offers a more accurate view of how securities perform since they tend to have different values. It is worth noting that some people may refer to rate of return as a return on investment (ROI), but they're actually separate terms.
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 in the stock market. So, the original stock price and the final values do matter. However, the time value of money is not considered.
The standard rate of return formula is:
ROR = (Final Investment Value-Original Investment Value/Original Investment Value) X 100 percent
However, it is crucial to understand the difference between stocks and shares even if some people tend to use them interchangeably when discussing stock market investments. You will need this knowledge when calculating your return on investment.
According to Investor.gov, a stock is the security that provides an ownership slice of each company in which you invest. On the other hand, shares represent the smallest complete unit of an individual company that you can own. 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 or within the specified holding period
- the number of shares you own in a company stock
- the current market value of the company shares
- the purchase price or initial cost of the shares you own
Calculating the Rate of Return on Stock
The procedure below will help you calculate the rate of return on stocks in an excel sheet or manually if you don’t have access to a rate of return calculator. 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 purchase 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. In addition, Taxes for Expats says you can find the information online based on when you bought the shares.
- Once you determine how many shares you bought at specific stock prices, you can calculate the total. For example, if you originally bought 100 shares of company ABC at $1.50 per share during an economic downturn and a second batch of 500 shares at $2.50 shortly after, your total initial 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 percent per year.
Bottom Line on ROR
It pays to learn the basics concerning stocks, such as calculating the return on investment. That way, you can estimate how it will perform in the future. Also, you can use such calculations or investment calculators to determine whether different investments have made or lost money over a specified period. And that will help you decide whether to hold them or dump them. In addition, you can determine your capital gains and the capital gains taxes due.
However, you can use alternative metrics, such as the cash flow rate of return or internal rate of return (IRR), to get a good picture of current and past performances of stocks to predict future results and make investment decisions. And you can also use return on assets, compound annual growth rate (CAGR), and return on equity valuation metrics.
I hold a BS in Computer Science and 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.