Return

Return is the financial world's ultimate report card. It's the gain or loss you make on an investment over a specific period, and it's the primary way we measure success. Think of it as the total reward you receive for putting your money to work. This reward isn't always a simple one-trick pony; it can come in two main flavors. The first is the appreciation in the price of your asset, known as a capital gain—the classic “buy low, sell high” scenario. The second is the income your investment generates for you while you own it, such as dividends from a stock or interest from a bond. For a value investing practitioner, return is not just a number. It's the outcome of a carefully made decision, and it must always be weighed against the risk taken to achieve it. The goal is not to chase the highest possible return at any cost, but to earn a satisfactory return from a sensible investment.

At its core, the return you get from most securities is a combination of two distinct components. Understanding both is crucial to seeing the full picture of an investment's performance.

• Capital Appreciation (or Capital Gain): This is the profit you make when the market price of your asset increases. If you buy a share of a company for $50 and its price climbs to $60, that $10 increase is your capital appreciation. It remains a “paper gain” until you sell the asset and “realize” the profit. This is often the most exciting part of investing, but it can also be the most volatile.
• Income: This is the cash that an investment pays you directly, simply for owning it. It's a more predictable and steady component of return. For stocks, these payments are dividends, which represent a share of the company's profits. For bonds, it’s the regular interest payments. This income can be taken as cash or, even better, reinvested to buy more of the asset, which is the secret sauce behind Compounding.

Just saying you “made money” isn't enough. To compare different investments and truly understand your performance, you need to measure your return in standardized ways.

This is the most honest and complete measure of performance. Total Return combines both capital appreciation and any income received during the holding period. Example: You buy a stock for $100. Over one year, its price rises to $108 (an $8 capital gain). During that year, it also paid you $4 in dividends. Your total return is $8 + $4 = $12. For stocks, this is often called Total Shareholder Return (TSR). Always insist on looking at total return, as it prevents you from being misled by a high dividend yield on a stock whose price is plummeting, or vice versa.

To easily compare the performance of different-sized investments, we express the total return as a percentage of the original investment. This is often called the Return on Investment (ROI). The formula is straightforward: Rate of Return = (Total Return / Original Cost of Investment) x 100% In our previous example: ($12 / $100) x 100% = 12%. A 12% return allows you to objectively compare this stock's performance against a different investment, like a rental property or another company's stock, regardless of their initial costs.

While ROI tells you about your return, value investors also dig deeper into how well the company itself generates returns. A key metric is Return on Equity (ROE), which calculates how much profit a company generates for every dollar of shareholders' equity. A business that can consistently produce a high ROE without using too much debt is often a high-quality “compounding machine.”

A true value investor thinks about return in a more nuanced way than the average market participant. It's not just about the final number, but about the quality, sustainability, and real-world value of that number.

The old Wall Street adage is “high risk, high return.” Value investors flip this on its head. The goal is to find opportunities for high return with low risk. This isn't magic; it's the result of diligent research. By buying a wonderful business at a price well below its intrinsic value, you create a “margin of safety” that both reduces your downside risk and increases your potential return. Your return is your reward for doing your homework and bearing uncertainty, not for gambling.

The return you see on your statement is your Nominal Return. But what really matters is your Real Return—the return after accounting for inflation. If you earn an 8% nominal return but inflation is 3%, your purchasing power has only grown by 5% (8% - 3%). Inflation is a silent tax that erodes the value of your gains over time. This concept is fundamental to the Time Value of Money. Always think in terms of real, inflation-adjusted returns to understand your true progress.

The most powerful returns are not earned in a year, but over decades. This is thanks to the magic of compounding, where you earn returns not just on your initial investment, but on your accumulated returns as well. A good return, when given enough time, can create astonishing wealth. Therefore, a value investor's concept of return is inherently long-term. When evaluating a potential return, you should also consider your opportunity cost—the return you could have earned from the next best alternative investment you passed up.