Economic profitability: key to understanding a company's profitability

▶ Economic profitability as an indicator of business performance

In investment analysis, there is a fundamental concept that every investor must master: what is a company’s profitability. Known by its acronym ROI (Return on Investments or return on investment), economic profitability represents the return we get when investing capital in a business versus other available alternatives.

Contrary to what many believe, understanding economic profitability goes far beyond simply comparing numbers. This indicator allows us to evaluate how efficiently a company converts its resources into profits, crucial information for those looking to build a solid investment strategy.

▶ Deciphering the concept: what is a company’s profitability?

Economic profitability basically measures a ratio: how much money a company generates relative to the assets it owns. When we buy shares, we want to know if our money will work hard or sleep. This metric answers exactly that.

Although the concept sounds straightforward, its application requires precision. We always start with historical data — past results — which allow us to project future behaviors. The logic is simple: “if I invest X, I should expect to obtain Y.”

An important detail: not all high ROIs indicate successful opportunities. Large tech companies that dominate the market today went through years of negative returns. Amazon is an emblematic case.

▶ Lessons from the giants: Amazon and Tesla under the ROI lens

The Amazon case: For several periods, Amazon investors recorded losses. The ROI remained negative, which would have scared any conventional analyst. However, those who maintained their position witnessed a spectacular transformation. The company went from burning money to generating extraordinary margins, turning a “terrible paper” investment into real fortune.

The Tesla case: Even more dramatic is the example of Tesla. Between 2010 and 2013, the company accumulated significant operational losses. The numbers showed an ROI of -201.37% at the end of 2010. Any rational investor would have fled. However, anyone who held on until today would be celebrating accumulated gains exceeding 15,316%.

These examples demonstrate that historical ROI is a tool, not an oracle. Its value depends entirely on the business context.

▶ Economic profitability versus financial profitability: a necessary distinction

These terms are often confused. The difference lies in what is measured:

• Economic profitability: evaluates the return on total assets of the company
• Financial profitability: focuses solely on equity

Although the distinction may seem technical, it significantly impacts how we interpret business performance. The same company can show divergent results depending on which of these metrics we use.

▶ The formula: how to calculate economic profitability

The calculation is straightforward. It does not require complex models:

ROI = (Earnings / Actual Investment) × 100

This equation works for both individual investors and analyzing corporate operations. If I buy shares at 10 euros and sell them at 15, I can calculate my personal ROI. Similarly, when Inditex invests in new stores and measures its return, it applies the same logic.

▶ Practical applications: two concrete examples

Scenario 1 - Investment in individual stocks:

We have 10,000 euros to distribute between two assets, allocating 5,000 euros to each. After the period:

• Asset A: capital grows to 5,960 euros → ROI = 19.20%
• Asset B: capital falls to 4,876 euros → ROI = -2.48%

Clearly, Asset A presents a more attractive profile.

Scenario 2 - Business investment:

A company invests 60,000 euros in remodeling its establishments. The subsequent appraisal values these improvements at 120,000 euros.

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

The investment doubled its value, indicating a successful project execution.

▶ When is ROI truly useful

This indicator shines particularly in “Value” investment strategies, where we seek established companies with clear trajectories and predictable results. Here, historical ROI has high predictive power.

However, it loses effectiveness in high-growth companies (Growth stocks). Innovative companies invest massively today in research and development expecting profits tomorrow. A low or negative ROI does not indicate failure but a different strategic bet.

Apple exemplifies this well: its ROI currently exceeds 70%, reflecting how brand margins and technology are efficiently converted into profits.

▶ Advantages of analysis through economic profitability

• Simple and direct calculation, no sophisticated tools required
• Considers the total investment made, providing full context
• Data is accessible in public financial statements
• Works comparatively across different assets and sectors
• Applies to both individual investors and corporate evaluations

▶ Limitations we cannot ignore

• Built on historical data, making reliable future predictions difficult
• Little use for valuing companies in transformation or innovation phases
• Companies with low investment expenses can easily manipulate their results
• Does not capture qualitative factors such as emerging competitive advantages or systemic risks

▶ Summary: integrating ROI into your investment analysis

Economic profitability is an essential component, never the sole tool. A high ROI can indicate an efficient company or one that simply does not invest enough in the future. A low ROI could signal inefficiency or an aggressive growth strategy.

The right approach requires a multidimensional vision: examine ROI along with other ratios (PER, EPS), understand the nature of the business, and distinguish between traditional sectors versus innovation-oriented sectors. In biotechnology or artificial intelligence, operational ROI may be less relevant than the ability to reach technological milestones. In energy services or food distribution, it is decisive.

Finally, knowing what a company’s profitability is allows you to go beyond superficial figures. It empowers you to identify genuine opportunities and avoid traps that lurk for inattentive investors.