There is but a single reason to make an investment: to obtain a positive return. One indicator of return is an investment’s alpha statistic, which quantifi es the diff erence between an investment’s expected return and its actual recent performance (outperforming or underperforming) given its risk. A stock or mutual fund with a positive alpha means the company did better than expected for its level of risk; a negative alpha indicates poor performance. Alphas for individual stocks, mutual funds, and other investments are available online through brokerage fi rms and advisory services. Alphas are an important statistic, but they are based on past performance and, thus, provide only a guide for future performance.

While you cannot know the exact performance of any investment in advance, you certainly will want to pay no more than the “right price” for the investment given its potential rate of return. Calculating returns on a potential investment involves fi ve steps. Armed with these data, you will be better positioned to make informed decisions:

1. Use beta to estimate the level of risk of the investment.

2. Estimate the market risk.

3. Calculate the required rate of return.

4. Calculate the potential rate of return on the investment.

5. Compare the required rate of return with the potential rate of return on the investment