metrics explained

Return on investment vs Return on equity: What's the Difference?

When it comes to making money from investing in stocks, there are two key metrics that are often used to gauge success: return on investment (ROI) and return on equity (ROE). Both ROI and ROE are important, but they measure different things.

ROI measures the percentage return on an investment, while ROE measures the percentage return on the equity that has been invested. In other words, ROI measures the "profitability" of an investment, while ROE measures the "efficiency" of that investment.

Here's a more detailed look at the difference between ROI and ROE:

What is return on investment (ROI)?

ROI is a simple concept: it measures the percentage return on an investment. To calculate ROI, you simply take the gain from an investment (in both cash and stocks) and divide it by the cost of the investment.

For example, let's say you invest $1,000 in a stock that goes up by 10% over the course of a year. Your ROI would be 10%, because you made a $100 profit on your $1,000 investment.

ROI is a popular metric because it's easy to calculate and it provides a clear picture of how profitable an investment has been. However, it's important to remember that ROI is a relative metric. In other words, it only tells you how an investment has performed in comparison to other investments.

For example, let's say you have two investments:

  • Investment A: An investment in a stock that goes up by 10%
  • Investment B: An investment in a stock that goes up by 20%

Both investments have the same ROI (10%), but investment B is clearly the more successful investment. This is why ROI is often used in conjunction with other metrics, such as ROE.

What is return on equity (ROE)?

ROE is a metric that measures the percentage return on the equity that has been invested. Equity is the portion of the investment that is owned by the investor; it's the "net" investment, after subtracting any debts or liabilities.

To calculate ROE, you take the net income from an investment and divide it by the average equity of the investment.

For example, let's say you have an investment that has a net income of $100,000 and an average equity of $500,000. Your ROE would be 20%.

ROE is a popular metric because it provides a clear picture of how efficiently an investment is being used. Unlike ROI, ROE is not a relative metric; it's an absolute metric. This means that it can be used to compare investments without having to worry about the size or cost of the investment.

For example, let's say you have two investments:

  • Investment A: An investment with a ROE of 10%
  • Investment B: An investment with a ROE of 20%

Both investments have the same ROI (10%), but investment B is clearly the more efficient investment. This is why ROE is often used in conjunction with other metrics, such as ROI.

The Bottom Line

ROI and ROE are both important metrics for measuring the success of an investment. However, it's important to remember that they measure different things. ROI measures the profitability of an investment, while ROE measures the efficiency of that investment.

Both ROI and ROE are popular metrics, but they're often used in conjunction with other metrics. This is because no single metric can provide a complete picture of an investment's success.

If you're looking to measure the success of your investments, be sure to use a variety of metrics, such as ROI, ROE, and others. This will give you the most complete picture of your investment's performance.

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