What Does a Negative ROI Mean?

by Hunkar Ozyasar
ROI is a critical financial ratio that tells you the profitability of a project or business.


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ROI stands for Return on Investment and is one of the most versatile measures in the field of finance. ROI essentially tells you if you are getting a sufficient profit in relation to the amount of capital you have committed to a project or a corporation. ROI makes cross-project and cross-corporation comparisons easy and meaningful, allowing the investor to determine where to place her cash.

Calculating ROI

ROI equals net profits divided by capital invested, multiplied by 100. The net profit must be calculated after accounting for all expenses, including taxes. As an example, assume you buy $10,000 of Microsoft stock and pay $9 in commissions to purchase the shares. A year later, you sell your holdings for $10,400 and again pay $9 to your broker in commissions for the sale. Your profit, for tax purposes, is $10,400 - $10,000 = $400, less $18 in commissions, or $382. Assume you owe $70 in taxes directly attributable to this trade. After-tax profits are therefore $312. ROI equals $312/$10,000 *100 = 3.12 percent.

Negative ROI

The ROI will be a negative figure if the project has lost money. For example, you will end up with a negative ROI figure in the stock trade in our example, if the purchase price of Microsoft exceeds the sum of the sales price, commissions and indirect expenses. If you had sold Microsoft for $10,015, for example, the sale price would have been greater than the purchase price and, at first, the trade might look profitable. When you subtract the $18 in commissions, however, the net profit from the trade would be $15 - $18 = -$3, or a loss of $3. Since you lost money, you will not owe any taxes. ROI would be -$3 / $10,000 *100 = 0.03 percent.

Taxes and Leverage

If the project has made money before taxes, it will have a positive ROI after taxes, too. The tax rate is never more than 100 percent and, therefore, the tax authority won't take all of your profits. So if you have some profits before taxes, you will never end up with a negative ROI after profits.

The same is not true for interest expenses, however. It is possible to have a profit before interest expenses and a negative ROI after interest is deducted. Assume you buy $10,000 of Microsoft stock and sell it for $10,400, again paying $18 in commissions. But assume you put only $5,000 out of pocket this time and borrowed another $5,000, on which you owe $500 in interest. Now, the ROI is a negative figure because, due to the interest expense, the net income turns into a loss.

Return On Equity

When financial analysts calculate the ROI of stockholders, they refer to their results as Return on Equity, or ROE. The concept, however, is the same. ROE equals the firm's net income after accounting for all expenses, divided by shareholder equity. You can multiply the result by 100 to turn it into a percentage. By scanning the ROE of different firms, investors can make a fair, apples-to-apples comparison.

However, you must also take risks into account when selecting an investment. While one venture or company may offer a superior ROI or ROE, a relevant question to ask is "How much of my money do I lose in the worst-case scenario?"

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