Investing in Unprofitable Companies

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By Lee Sherman

It has long been believed that the goal of any publicly held company is to provide a quick return on investment for its shareholders. But the success of a few recent companies is turning that conventional wisdom on its head.

Some of the most well-known and admired publicly-listed companies like Tesla, the electric carmaker and Spotify, the music streaming service report billions in losses every year. The ride-sharing provider Uber lost $4.5 billion last year but is expected to list publicly next year.

So why do investors still pump money into these money-losing ventures? While it may defy logic, there are still reasons to consider it.

To a certain extent, putting money into a company in its formative stages makes sense for both the investor and the company. This approach is called angel investing, where you can put a small amount (say $25,000) into a company) to help it as it is developing software, hiring a team, and figuring out the product/market fit. By definition, these companies will be unprofitable at the start as they don’t even have a product in the market.

As they grow and larger venture capitalists put more capital into the company, the companies valuation will increase and those investors which got in on the ground floor may ultimately benefit. The trend toward investing in unprofitable companies is being driven by the tech sector.  For companies like Tesla, Uber, and Spotify, who are attempting to solve really big problems such as disrupting the mobile landscape or replacing music ownership with on-demand streaming, these huge injections of cash make sense. For years, Amazon pursued a strategy of reinvesting in the company so that it could focus on growth over profits.

Of course, nobody really knows if they will prove to live up to their valuations. Yes, there is a lot of hype surrounding these companies but there is no question that they are solving real problems for their customers and (in Spotify’s case at least) they are attracting a critical mass of loyal customers.

Consider Amazon, which remained unprofitable for much of its existence, even after going public in 1997, but suddenly started reporting a profit in 2001. Amazon’s profits over the last 20 years total a little less than $8 billion but they are enough to make its founder, Jeff Bezos, the richest man in modern history.

In part, investors are drawn to these companies due to the charismatic men like Elon Musk and Jeff Bezos who run them but this cult of personality makes for a bad investing strategy. Stick to following their exploits in the tabloids and remember that of the companies that went public last year, just 17 percent of tech companies were profitable compared with 43 percent of non-tech companies (according to data from University of Florida’s Warrington College of Business).

Despite this, investors are still drawn to unprofitable companies, hoping that, in the long run, they will indeed become profitable. If you still want to add one of these (admittedly exciting) companies to your portfolio, ask your financial advisor to help you determine which ones show the best potential for long-term growth.

Lee Sherman is a contributing writer to www.myperfectfinancialadvisor.com, the premier matchmaker between investors and advisors. Lee is an experienced journalist and editor with over 30 years of expertise with a significant history of writing in the personal finance and technology arenas.

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