What 'Average Return' tells us?

Haai,

Today we are starting with the most basic term used by Investors in analyzing the stock ; Average Return.  But before discussing why they are using this let us understand what it is all about and what does this term trying to tell us.

Do you remember your school days? When other than topper students used to get remark like "He/She is an average student"... and still we felt relaxed ..glookin'!! At least we are average 💥💥 

What is Average Return and How to calculate it?

Let's learn step-by-step together to move above an average learner and by the time we realized we used 'AVERAGE' as a benchmark of our academic performance.

I'll give you an example of Mr. Bambani. He has $1000 and want to utilize this money by investing in FMCG industry.

To make the illustration easier, let's take a case example. Suppose the Return on capital Employed (ROCE)of five companies in the FMCG industry over the past decade is as follows : 15%, 12%,9%, 11% and 7%.

To calculate the average ROCE in the industry, we add up each ROCE and then divide it by number of companies. That yield an average of 10.80%.

From this data, we see that three companies produce return above average. All three companies are likely to have competitive advantages, and of course, to conclude with certainty, Mr. Bambani needs to explore their performance further.

Why it is important to consider?

Average Return is basically act as an indicator to show whether the company have competitive advantage or not. As if company is able to generate more return than their average return. On the other hand, Return lower than their average return might have an impact on business failure because investors will not get attracted.

Capital investment is the source of funding for the company, through which company can expand their operations and introduce new goods or services to the customer in a very competitive manner. If company is unable to generate even the average return then the cost of funds gets increased due to lack of certainty among the investors.

Here also Mr. Bambani will be interested in companies having more than average return. Now we have a clear understanding what is average return ;why this term is used by investors and how we can calculate and compare to get indication for good investment alternatives.

Thankyou for your patience!

I'll be right back with more basic terms used in Finance and try to make Mr. Bambani more judicious✌