The payback period measures how long a project or investment takes to repay any initial outlay. For example, if you spend £1,000 on shares, then receive a dividend of £200 at the end of every year, the payback period is five years.
Payback is useful because it focuses on cash flows – a vital consideration in any investing decision. But it’s also flawed. It ignores that £200 received in one year is worth more than £200 received after three years.
Discounted payback tries to resolve this (usually lengthening the payback period). Even then critics say the method takes no account of overall returns. In short, payback doesn’t really tell you whether you should invest or not. For that, you need other measures, such as return on capital.