Economic Profitability (ROI): The Metric Every Investor Must Master

Why Economic Profitability Is Critical for Your Investment Decisions

When considering investing in a listed company, we usually look at the stock price, the P/E ratio, or EPS. But there is an indicator that many overlook: ROI or economic profitability. This ratio allows you to understand exactly how much money a company generates relative to its assets. Put simply: it’s the return you get for investing your capital in a particular company compared to other available alternatives.

Economic profitability acts as a compass for equity investors. It shows us a company’s operational efficiency and, therefore, the quality of its management. Although it seems simple, this metric contains an interesting complexity that we will review throughout this analysis.

Advantages: Why You Should Consider ROI in Your Analysis

Before diving into how it’s calculated, let’s see why ROI is so valuable:

• Extreme simplicity: You don’t need to be a mathematician to understand it. The formula is so straightforward that anyone can interpret it.
• Universal applicability: It works whether you are an individual investor or analyzing a listed company. The same principle applies in both cases.
• Accessible information: You can easily find these data in financial databases.
• Comparability: It allows comparing assets of completely different natures under equal conditions.
• Dual validity: It’s as useful in your personal portfolio as when evaluating companies for professional investment.

Limitations of ROI: What You Need to Know

However, ROI is not a panacea. It has important limitations that every investor should consider:

• Historical bias: It’s calculated based on past data, making reliable future projections difficult. The past doesn’t always predict what’s to come.
• Trap in growth companies: Firms investing heavily in R&D or development may show negative ROI, but that doesn’t mean they are bad investments. In fact, quite the opposite.
• Distortion by low invested capital: Companies that invest little can easily manipulate their ROI results without reflecting real good management.

How to Calculate Economic Profitability: The Formula

The mechanics are straightforward. Economic profitability is obtained by dividing net profit by total assets, multiplied by 100 to get the percentage:

ROI (%) = (Net Profit ÷ Total Assets) × 100

This allows you to instantly see how much money you have earned or lost relative to what you invested. The result will tell you whether your decision was correct or not.

Practical Cases: When Theory Turns into Real Money

Example 1: Individual Investment in Two Stocks

You have €10,000 and decide to distribute it between two stocks: €5,000 in stock A and €5,000 in stock B.

After the investment period:

• Stock A: Your €5,000 becomes €5,960
• Stock B: Your €5,000 drops to €4,876

ROI calculation for A: (960 ÷ 5,000) × 100 = 19.20%

ROI calculation for B: (-124 ÷ 5,000) × 100 = -2.48%

The conclusion is clear: A outperformed B, although this could change in the future.

Example 2: Corporate Project

A company invests €60,000 in remodeling its locations. After the intervention, those locations are valued at €120,000.

ROI of the project: (60,000 ÷ 60,000) × 100 = 100%

The invested capital doubled. That’s the kind of efficiency we look for in companies.

Amazon and Tesla: Lessons from Extreme Economic Profitability

The Amazon Paradox

For years, Amazon showed a negative ROI. Investors were losing money on paper while Bezos reinvested everything into expansion. Anyone who only looked at ROI would have fled in terror. However, those who held onto their shares turned that initial “bad investment” into one of the best decisions of their lives.

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

Between December 2010 and December 2013, Tesla showed an ROI of -201.37%. Imagine that: for every euro invested, you lost more than 2 euros in profitability terms. Any rational analyst would have dismissed the company as a disaster.

But those who held their positions from then until today have seen their capital multiply more than 15 times. The historical ROI was a disaster; the actual result was a fortune.

Economic Profitability vs. Financial Profitability: They Are Not the Same

This is a common mistake. Many investors confuse both terms:

• Economic profitability: Calculates the return on the total assets of the company. It includes both equity and debt.
• Financial profitability: Focuses exclusively on own funds. It excludes the debt component.

Depending on the company’s financial structure, they can yield radically different results. That’s why it’s crucial not to mix them.

Investment Strategies: When to Use (y and When to Ignore) ROI

For Value Investing

If your strategy is value investing (investing in traditional stocks), ROI is your ally. These companies have extensive histories, predictable results, and extrapolatable trajectories. ROI helps you identify which of these “cheap” stocks is truly a bargain.

For Growth Investing

If you’re looking for growth companies, ROI can be misleading. Companies betting on innovation invest massively today expecting profits tomorrow. A low or negative ROI is almost guaranteed in companies like biotech or artificial intelligence in their early phases.

The Apple Case: Exceptional ROI

Apple is the opposite example of Amazon and Tesla. This company maintains an ROI exceeding 70%, making it one of the most efficient at generating returns on its investments. Why? The power of its brand and technological advantage generate extraordinary margins. When a company can invest in R&D and produce products sold with luxury margins, ROI skyrockets.

Fundamental Difference: Economic Profitability in Different Sectors

A 10% ROI can be excellent in a food distribution company but disappointing in a tech startup. That’s why ROI should never be viewed in isolation:

• Service and infrastructure sectors: We expect moderate but consistent ROI.
• Innovation and technology sectors: Initially low ROI, exponential later if successful.
• Real estate and energy sectors: Stable, predictable ROI with little room for surprises.

Conclusion: Use ROI, But Not Only

Economic profitability is an essential indicator, but it shouldn’t be the only one in your fundamental analysis. A high ROI is attractive, but a company with low ROI could be on the verge of unlocking its potential. Likewise, an exceptional long-term ROI (like Apple) reflects operational excellence.

The smart approach is to combine ROI analysis with other ratios, understand the sector in which the company operates, and, most importantly, distinguish whether we are dealing with a traditional value or a growth play. This combination of criteria is what separates investors who succeed from those who simply read a number and make a decision.