ROI and Economic Profitability: The Fundamental Metric for Investment Evaluation

Why ROI Determines the Success or Failure of an Investment

When it comes to investing in stocks or analyzing a company’s strength, there is one indicator that takes center stage: ROI, also known as economic profitability. It is a metric that answers a simple but crucial question: how much money am I really earning with my invested capital?

For years, this ratio has been fundamental for equity investors to make informed decisions. However, history has taught us fascinating lessons about how ROI does not always tell the full story. Companies like Amazon and Tesla demonstrate that negative economic profitability in the early years does not necessarily mean inevitable failure.

Cases That Challenge ROI Logic

Amazon’s Example: Losses That Turned into Fortune

In the mid-2000s, Amazon showed a concerning negative ROI. For several consecutive periods, investors saw their capital decrease year after year. Any analyst relying solely on this indicator would have advised selling immediately. However, those who held their positions witnessed a spectacular transformation of the company.

The lesson is clear: economic profitability is especially valid for traditional companies with a long stock market history and predictable results. For these, the ratio is highly reliable.

Tesla: From -201% to +15,316% Return

Tesla’s case is even more extreme. Between 2010 and 2013, this electric vehicle manufacturer accumulated devastating economic losses, reaching a ROI of -201.37% in December 2010. The numbers were so alarming that any cautious investor would have run away from their position.

Now, let’s look at what happened afterward: from that date to the present, Tesla has generated returns of +15,316%. That is, those who resisted the temptation to sell during the darkest moments obtained a true fortune.

Understanding Economic Profitability: Definition and Mechanics

Economic profitability represents the return we get from investing capital in a company instead of doing so elsewhere. Although it sounds simple, its application requires some analytical rigor.

This indicator is always calculated based on historical data, which means it provides a trend to extrapolate into the future. The principle is straightforward: “the more I invest, the more I get.” Its usefulness lies in facilitating informed investment decision-making.

However, an important warning: today’s economic profitability does not guarantee tomorrow’s results. While a capitalist will typically seek companies with higher ROI, this is not always a guarantee of future success.

Critical Difference: Economic Profitability vs. Financial Profitability

Many people confuse these two concepts, although their differences are fundamental. Financial profitability is based on the company’s equity, while economic profitability considers total assets. Depending on the company’s structure we analyze, these differences can produce completely different results.

Calculation Formula: Simply Effective

Calculating ROI is straightforward and does not require mathematical sophistication:

ROI = (Profit Obtained / Investment Made) × 100

This simple formula allows us to evaluate how much money we have gained or lost on any specific investment. The interesting part is that ROI applies both to our personal stock investments and to corporate investments a company makes in its assets.

Practical Exercises: Applying Economic Profitability

Scenario 1: Decision Between Two Stocks

Suppose we have €10,000 to invest in two different stocks, allocating 50% to each. At the end of the period, one position is worth €5,960, while the other reaches €4,876.

For the first asset: ROI = ((5,960 - 5,000) / 5,000) × 100 = 19.20%

For the second asset: ROI = ((4,876 - 5,000) / 5,000) × 100 = -2.48%

The first alternative is clearly superior, showing gains while the second incurs losses.

Scenario 2: Corporate Investment in Infrastructure

A company invests €60,000 in remodeling its stores. After a recent appraisal, these locations reach a value of €120,000.

ROI = ((120,000 - 60,000) / 60,000) × 100 = 100%

In this case, the investment has doubled the value, demonstrating excellent capital allocation.

When Is ROI Truly Useful?

Economic profitability becomes especially important when implementing an investment strategy in traditional companies, i.e., businesses with a long stock market history, reliable historical results, and traceable projections. In these cases, ROI works as an effective compass.

However, when dealing with growth companies or “growth companies,” ROI can be misleading. These organizations typically reinvest their earnings into research, development, and innovation, which generates negative ROI that does not reflect business failure but a deliberate strategy.

Apple offers an interesting contrast: with an ROI exceeding 70%, this company demonstrates how a structure of high margins and brand dominance allows for exceptional investment profitability. It is one of the best examples of capital allocation efficiency.

Strengths of ROI as an Indicator

• Simple calculation and highly effective for comparisons
• Considers the total volume of the investment made
• Information readily available in financial statements
• Applicable to investments in assets of diverse nature
• Works for both individual analysis and corporate valuation

Limitations We Cannot Ignore

• Mainly based on historical data, making reliable future projections difficult
• Less useful for evaluating growth companies that prioritize R&D over immediate results
• Vulnerable to distortions if the company invests minimally in development
• Can provide misleading readings in research-intensive sectors

How to Incorporate Economic Profitability into Your Analysis

Although ROI is important, it should never be the sole indicator guiding our decisions. Economic profitability must be complemented with a comprehensive analysis that includes ratios like PER, EPS, and other business health indicators.

It is especially critical to differentiate the type of company we are evaluating. A biotech or an AI startup operates under completely different dynamics than an energy distributor or a food company. In the first cases, expecting high ROI in early years is irrational.

The key is to adopt a holistic perspective: observe ROI trends over time, understand the corporate strategy behind the numbers, and recognize that economic profitability is only one piece of the investment puzzle. Combining this metric with solid fundamental analysis will enable us to make more accurate and profitable decisions in the long run.