ROI in cryptocurrencies and profitability: How to interpret the performance of your trades

▶ What Does ROE Mean and Why Is It Important for Trading?

In the world of financial operations, both in traditional markets and cryptocurrencies, understanding what ROE means is essential for evaluating the efficiency of any investment. ROE —which stands for Return On Equity— measures how effectively an organization converts shareholders’ capital into actual profits. For traders, this concept is especially useful when analyzing crypto projects or comparing the performance of different digital assets.

Financial profitability reveals how much profit a company generates with each unit of capital it owns. If an organization has an ROE of 20%, it means that for every $100 in equity, the company produces $20 in net earnings. This indicator allows operators to quickly identify how efficiently an entity uses its resources to create value.

● Calculating Profitability: Formula and Practical Application

To obtain ROE, divide the annual net income by the total shareholders’ equity, multiplying the result by 100 to express it as a percentage:

ROE (%) = (Net Income / Shareholders’ Equity) × 100

Net income represents the final profit after deducting all expenses, while shareholders’ equity is the residual value of assets after debts are paid. Let’s take a software organization as an example: if it reports a net profit of 18,500 million dollars with equity of 124,000 million, the calculation would be:

ROE = (18,500 / 124,000) × 100 = 14.9%

This percentage indicates that the company generates an annual return of 14.9% on the capital invested by its owners.

● Interpreting Profitability in Different Contexts

When comparing companies within the same sector, a higher ROE suggests better efficiency in generating profits. However, interpretation requires context: an entertainment software company might have an ROE of 42.1% (like certain tech giants), while an internet software company could hover around 14.9%. Although the first number is higher, it’s crucial to verify which aligns better with the averages of its respective segment.

For investors exploring the stock market, the weighted average ROE of the largest caps in the S&P 500 was around 18.6% in 2017. Companies like Alphabet Inc. have shown figures close to 26.41%, while others operate with more modest returns near 8.37%. These variations reflect differences in business models and operational efficiency.

● Hidden Traps of High ROE

An unusually high return should prompt further investigation, as it could indicate anomalies:

Negative income or equity: When a company has accumulated losses, a single profitable year can produce a deceptively high ROE. Analysts must verify that both figures are positive.

Earnings volatility: A company that experienced years of deficits but reports exceptional profit in a specific quarter may show a distorted ROE that does not reflect sustainable performance.

Excessive leverage: Companies can artificially inflate their ROE by increasing debt. While leverage works when profits from borrowed money exceed its cost, it poses significant risk. Financial experts note that leverage acts as “a double-edged sword” that amplifies both gains and losses.

Share buybacks: When a company reduces its equity through share repurchases, the denominator in the ROE formula decreases, artificially raising the indicator without real improvement in profitability.

One-off events: Inventory depreciation or non-recurring events can distort net income for a specific year, creating the illusion of improvements that do not persist.

▶ From Traditional ROE to ROI in Crypto Asset Operations

Although ROE is mainly applied to listed companies, the concept of performance translates into the crypto world through ROI (Return On Investment). While crypto assets operate under different dynamics than traditional stocks, they allow traders to speculate on short-term price movements and calculate returns similarly.

ROI in cryptocurrencies is calculated by subtracting the purchase price from the sale price, dividing the result by the initial investment:

ROI = (Sale Price - Purchase Price) / Purchase Price × 100

For example, if you buy a crypto asset at $5,000 and sell it at $20,000:

ROI = (20,000 - 5,000) / 5,000 × 100 = 300%

This means you tripled your initial investment, achieving a 300% return.

● Why Measure ROI in Cryptocurrency Trading

Assessing actual performance: Calculating ROI helps determine whether your trades in Bitcoin, Ethereum, altcoins, or other crypto assets are generating expected returns. A positive ROI indicates an upward trend of the asset, while a negative one signals value loss. Crypto assets with negative ROI require cautious handling, as they might never recover the initial investment.

Optimizing the portfolio: Identifying which positions perform better enables informed decisions about what to hold and what to liquidate. If an investment does not meet its performance goals, it might be time to redeploy capital into assets with higher potential.

Managing cash flow: Understanding how much each operation generates is crucial for calculating available cash and making new investments. A positive cash flow, derived from accumulated positive ROIs, is essential for growing a portfolio.

● Limitations of ROI in Cryptocurrencies

However, ROI does not tell the whole story. Several additional factors affect actual profitability: transaction fees, trading commissions, spreads, and varying costs depending on each platform. Moreover, ROI does not consider time, a key factor in evaluating whether a gain justifies the risk taken.

For a thorough assessment, traders should analyze the historical performance of the specific crypto asset, its evolution over previous years, ongoing projects, and behavior across market cycles. Just as stock analysts consult additional metrics like ROE to understand the full picture, cryptocurrency operators should complement ROI with technical analysis, fundamental project evaluation, and comprehensive risk management.

In conclusion, both ROE in companies and ROI in cryptocurrencies are valuable tools for measuring returns, but none should be used in isolation. Sustainable profitability requires a multidimensional understanding of markets, constant monitoring of complementary metrics, and disciplined strategy execution.