How to calculate returns in stock market?

Now, everything in markets boils down to one thing. Generating a reasonable rate of return!

 If your trade generates a good return all your past stock market sins are forgiven. This is what really matters. 

Returns are usually expressed in terms of annual yield. There are different kinds of returns that you need to be aware of. The following will give you a sense of what they are and how to calculate the same… 

Absolute Return – This is return that your trade or investment has generated in absolute terms. It helps you answer this question – I bought Infosys at 3030 and sold it 3550. How much percentage return did I generate?

 The formula to calculate the same is [Ending Period Value / Starting Period Value – 1]*100

 i.e [3550/3030 -1] *100

 = 0.1716 * 100

 = 17.16%

 A 17.6% is not a bad return at all!

 Compounded Annual Growth Rate (CAGR) – An absolute return can be misleading if you want to compare two investments. CAGR helps you answer this question - I bought Infosys at 3030 and held the stock for 2 years and sold it 3550. At what rate did my investment grow over the last two years?

 CAGR factors in the time component which we had ignored when we computed the absolute return. 

The formula to calculate CAGR is ..

Applying this to answer the question.. 

{[3550/3030]^(1/2) – 1} = 8.2% 

This means the investment grew at a rate of 8.2% for 2 years. Considering the fact that Indian fixed deposit market offers a return of close to 8.5% return with capital protection an 8.2% return suddenly looks a bit unattractive. 

So, always use CAGR when you want to check returns over multiple years. Use absolute return when your time frame is for a year or lesser. 

What if you have bought Infosys at 3030 and sold it at 3550 within 6 months? In that case you have generated 17.16% in 6 months which translates to 34.32% (17.16% * 2) for the year. 

So the point is, if you have to compare returns, its best done when the return is expressed on an annualized basis.