ROI: The metric every investor must master to make smart decisions

Why ROI is Essential in Your Investment Analysis

When we decide to allocate capital to an asset, the question that truly matters is simple: how much will I gain or lose? This is where ROI comes into play, formally known as Return on Investments or economic profitability. This indicator measures the return we get from investing our money in a specific company instead of an alternative.

At first glance, it seems straightforward, but in practice, it has important nuances that investors tend to overlook. Economic profitability is always calculated with historical data, which allows us to identify trends. However, that does not guarantee future success. Many of the companies that are today’s tech giants spent years with negative ROI.

Let’s take two extreme examples that illustrate this perfectly:

Cases That Challenge Logic: Amazon and Tesla

Amazon experienced several consecutive years with negative economic profitability. Investors literally lost money on paper. However, those who kept their capital in the company would have achieved spectacular returns years later.

Tesla was even more radical. Between 2010 and 2013, ROI reached negative highs of -201.37%. Any conventional investor would have fled in terror. But those who held on until today would have seen their investment multiply more than 150 times.

These cases reveal an uncomfortable truth: current ROI is useful, but not infallible.

How to Differentiate Between Economic and Financial Profitability?

There is a widespread confusion here. Although the terms sound synonymous, they operate in different ways:

• Economic profitability: evaluates the performance on the total assets of the company
• Financial profitability: focuses only on the equity invested

This difference can lead to completely different readings of business performance, depending on each company’s capital structure.

The ROI Formula: Simpler Than You Think

The calculation is straightforward:

ROI = (Profit or Loss / Initial Investment) × 100

Let’s look at two practical examples:

Example as an individual investor:

You have €10,000 and decide to invest €5,000 in stock A and €5,000 in stock B. At the end:

• Stock A: €5,960 (gain of €960)
• Stock B: €4,876 (loss of €124)

ROI A = (960 / 5,000) × 100 = 19.20% ROI B = (-124 / 5,000) × 100 = -2.48%

Stock A is clearly superior, but note that B generated a loss.

Example as a company:

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

ROI = (60,000 / 60,000) × 100 = 100%

The investment doubled its value. An excellent result.

When ROI Is Your Most Reliable Ally

This indicator shines especially in Value investing strategies, where you look for established companies with a clear history and predictable results. Here, ROI gives you a direct read on operational efficiency.

Apple is a prime example: its current ROI exceeds 70%, demonstrating that it knows how to extract extraordinary margins from its investments thanks to the power of its brand and technology.

However, in Growth companies (growth), ROI can be misleading. A startup investing aggressively in R&D will show low or negative ROI, but could be building the next giant in the sector.

Strengths and Limitations of ROI

What it does well:

✓ Simple and direct calculation ✓ Captures the total investment made ✓ Easy to find in financial reports ✓ Applicable to diverse asset types ✓ Valid for both individual investors and corporate analysis

What it doesn’t do well:

✗ Fully based on historical data, difficult to project into the future ✗ Can distort the evaluation of innovation-oriented companies ✗ Companies with low investment spending can artificially inflate their numbers ✗ Generates “false signals” in sectors like biotech or artificial intelligence

The Verdict: ROI Is Necessary, But Not Sufficient

Economic profitability should be part of your analysis, not the whole picture. Combine it with other ratios like PER, EPS, and qualitative industry analysis.

Remember: a low ROI can indicate both a failing company and an innovative one investing today to harvest tomorrow. Only a comprehensive view of the company will allow you to distinguish an opportunity from a trap.

When evaluating where to deposit your capital, consider ROI as a tool within a broader arsenal of indicators and fundamental analysis.