What does the term 'return on investment (ROI)' measure?

Return on Investment (ROI) is a crucial metric used to evaluate the profitability of an investment. It is calculated by taking the net profit from the investment, dividing it by the initial cost of that investment, and multiplying by 100 to express it as a percentage. This percentage provides a straightforward way to assess how much gain or loss was generated relative to the amount invested.

Understanding ROI is essential for investors as it helps them compare the efficiency of different investments on a standard scale. A higher ROI indicates a more profitable investment, making it easier to make decisions about where to allocate funds. This measure does not indicate the risk level, duration, or liquidity of the investment, which are separate considerations in the investment analysis process. By focusing exclusively on profitability, ROI serves as a direct indicator of financial success and helps investors evaluate their options effectively.