How economic profitability defines your investment decisions: a practical guide to ROI

The Metric All Investors Should Master

When you decide to invest your capital, you face a fundamental question: where will you get the highest return? The answer is not always obvious. Although many analysts talk about PER, EPS, and other financial ratios, there is an indicator that transcends all complexities: economic profitability, universally known as ROI (Return on Investments).

This financial ratio is not just a number on a spreadsheet. It represents the true quality of business management, the ability of companies to convert investment into profit. Those operating in equities should consider ROI with the same seriousness as they do other fundamental ratios.

Economic profitability: a straightforward definition

We talk about economic profitability when quantifying the return generated by a company on its total assets. More directly: it’s the measure that tells us how much money we earn for each monetary unit invested in a specific company.

The calculation is always based on historical data. Although this may seem like a limitation, it is actually a strength: it provides a trend that we can reasonably project into our future decisions. The formula is as simple as it is effective: divide the profit obtained by the invested amount.

However, there is a crucial nuance that many investors overlook: ROI is especially revealing when analyzed together with the business context. A startup with negative profitability for years could become an industry giant. Conversely, a high ROI in a stagnant company might indicate it has reached its growth ceiling.

Amazon and Tesla: lessons from the negative ROI that changed everything

Consider Amazon, the largest e-commerce platform on the planet. For several consecutive periods, this giant reported a negative ROI. Investors who only looked at this indicator would have seen only losses. They withdrew capital. They regretted it later.

Those who maintained their position in Amazon from those dark years until today saw their capital transform into a fortune. Negative ROI was not an indicator of business failure, but of an aggressive reinvestment strategy.

Tesla offers an even more dramatic picture. Between 2010 and 2013, the electric vehicle company showed an ROI of -201.37% in its first fiscal year. Subsequent quarters did not improve significantly. Any rational investor would have sold in panic. However, those who held on from December 2010 until today experienced an accumulated return of over +15,316%. That’s not just profit; it’s wealth transformation.

These cases teach us that ROI has different validity depending on the type of company. In value strategies, where we seek established companies with a broad stock market history, ROI is a reliable filter. In growth (Growth) companies, the indicator can be misleading if interpreted in isolation.

Key differences: economic versus financial profitability

Many investors confuse these concepts because the terms “economy” and “finance” seem interchangeable. The reality is that they operate on different bases. Financial profitability is calculated on equity (net worth), while economic profitability works on total assets of the company.

This difference is not semantic. Depending on the company’s capital structure, results can vary significantly. A highly leveraged company will show very different financial returns compared to its economic profitability.

Practical formula: how to calculate ROI

The equation is straightforward:

ROI = (Net Profit / Total Investment) × 100

This calculation works for both individual investors and corporate analysis. If you buy shares of Inditex at 10 euros and sell them for 15, your personal ROI is 50%. Similarly, Inditex has its own ROI based on how it profits from its investments in infrastructure and expansion.

Real-world application: two calculation scenarios

Scenario 1: Equity investment

You have €10,000 to invest equally in two stocks: A and B (€5,000 each). After a period:

• Stock A: €5,000 → €5,960
• Stock B: €5,000 → €4,876

For stock A: ROI = (960 / 5,000) × 100 = 19.20%

For stock B: ROI = (-124 / 5,000) × 100 = -2.48%

The comparison is clear: A generated gains while B resulted in losses. The investment decision leans toward A.

Scenario 2: Business investment

A company invests €60,000 in remodeling its stores. A subsequent appraisal values these locations at €120,000.

ROI = (60,000 / 60,000) × 100 = 100%

The investment doubled in value. This is an example of successful resource allocation.

When does ROI really matter?

The economic profitability figure is critical in two contexts: at a personal level and at a business analysis level.

For individual investors, ROI allows for direct comparison of options. If one investment offers 7% and another offers 9% under similar conditions, the math is simple.

For company analysts, ROI reveals management’s ability to convert capital into profit. There are countless cases where poor resource allocation destroys results. Apple is a counterexample: its ROI exceeds 70%, reflecting extraordinary margins derived from its brand and technology. This company knows how to profitably utilize every euro invested.

However, it is crucial to examine the historical trajectory of ROI, not just an isolated period. Profitability takes time. Analyzing a negative quarter could lead to incorrect conclusions about companies in strategic investment phases.

Economic profitability in specific sectors

ROI is not universal. Its interpretation varies by sector:

• Traditional sectors (food distribution, energy supply): we expect consistently positive ROI. A low ROI signals operational problems.

• Innovation sectors (biotechnology, artificial intelligence): we expect negative or low ROI for years. These companies reinvest aggressively in R&D&I seeking future profitability.

Avoid the mistake of comparing the ROI of a developing pharmaceutical company with that of an established distributor. They are different worlds.

Advantages of using economic profitability in your analysis

The popularity of ROI among financial professionals is no accident:

• Simple calculation that does not require complex models
• Considers total invested capital, not just a part
• Data is publicly accessible for listed companies
• Allows comparisons between assets of completely different natures
• Works for both personal decisions and business valuation

Limitations you should not ignore

Like any indicator, ROI has blind spots:

• It is entirely based on past data, making reliable projections difficult
• It can be misleading for growth companies that allocate massive capital to development
• Companies minimizing investment can artificially inflate ROI without real quality
• It does not capture inherent investment risks

Holistic interpretation: ROI within the complete analysis

The most common mistake among beginner investors is relying solely on ROI as their criterion. A low ROI does not mean imminent bankruptcy. A high ROI does not guarantee safety.

When evaluating a company for investment, integrate the analysis of economic profitability with:

• The type of business (Value vs. Growth)
• The phase of the business cycle
• Sectoral context
• Reinvestment trends
• Shareholder return

Reconsider the cases of Amazon and Tesla. Both showed catastrophic ROI. Both became extraordinary investment opportunities. The difference was understanding that negative ROI was temporary and strategic, not terminal.

Economic profitability is a compass, not a destination. Use ROI as an initial filtering tool, but always develop a multidimensional analysis. This way, you will avoid false positives (high ROI companies without growth) and false negatives (low ROI companies in expansion stages).