How to Estimate Return on Equity Investment?

Calculating the returns from your investments is crucial to analyzing them. However, estimating market-based returns also involves a degree of uncertainty. This element of uncertainty can be eliminated by using systematic methods to compute returns. Some can be as basic as looking at past returns and building expectations based on them.

You can invest in the best possible stocks as advised by your investment manager and still be confused what your return on equity (RoE) is. There needs to be a meaningful way to measure the performance of your equity investments. Different methods can be used by an investor depending on the investment objectives. You can make the best possible use of a calculator to compute these returns. Some methods to estimate your returns from equity investments are mentioned below:

• Simple Return

Computing the returns on equity shares under this method is a fairly easy calculation. One needs to make a note to include the dividends the equity shares pay during the tenure. Along with such payout that the equity has on offer, the difference between the value at the sale date and the purchase date is calculated to arrive at net proceeds. These proceeds, with the periodic payouts, are divided by the purchase price to compute the return that the equity has on offer. Any charges incurred at the purchase or sale of such equity shares have to be accordingly added or subtracted in calculating net proceeds. Let us have a look at this with the help of an example:

• Compounded Annual Growth Rate (CAGR)

The limitation of Simple Return is solved by CAGR. For investments that are held longer than one year, the estimated returns will be higher whereas the returns on such equity shares is over the duration of the period of the investment in equity. In the above example, a 64% return is a lucrative investment option but, in fact, if the same was received over a period of 5 years, it wouldn’t be as high as 64%. The logic underlying CAGR is that the growth has been compounded over the duration of the investment and, thus, for calculating CAGR, we divide the terminal value by the initial investment. The result so derived is to be raised to the power of one, divided by the ‘n’ number of years, and subtracted by one. To summarize:

CAGR = Terminal value / Initial Investment) ^ (1 / ‘N’ years) -1

CAGR presents the investor with smoothened returns over the duration of the investment in equity.

Apart from the above listed estimation techniques, a more advanced and accurate measure will be adjusting the returns on equity with factors like inflation index, GDP, and more to arrive at the true return percentage. This will enable one to arrive at inflation-adjusted returns that the investor will earn over the years.

To conclude, an extra percent or two that an investor earns from investments in equity shares over longer durations, say 25 years or more, is a cherry on the cake considering the corpus that gets accumulated by the end of investment tenure.