(photo credit: PIXABAY)
When investors turn back the clock 19 years, just after the hi-tech Internet bubble popped, and do a post-mortem on what actually led to the bursting bubble, one of the conclusions reached is that money poured into companies that were losing money hand over fist. Investors had forgotten a very important investing principle: profits are important. Instead of making money, the narrative changed. We were told that what was important was revenue growth and the potential to change the world, and that profits will come at some time in the future. Well, what happened? Reason triumphed over “irrational exuberance” and the tech market crashed.
I have been getting many calls from investors who heard the news that Uber and Lyft, the popular ride-sharing companies, went public and started trading, and they want to invest. Now I am not giving investment advice at all, and if you want to invest, do your homework and make your own decisions, it’s just that I want to warn investors to be careful. Since their respective public offerings, the stock prices of both have not done well. Why? Because when drilling down to the actual financials of the companies, you find that they are both losing huge amounts of money. The We Company, the parent company of the very popular shared workspace company WeWork, is planning to do a huge IPO, on the heels of reported losses of $1.9 billion in 2018. Losses continue to mount, but to be fair revenues are growing rapidly. They are getting tons of press about the IPO, but is it a good investment? Maybe. There are many reasons that it is and many that it’s not. That’s why I said to do your own research and make your decision.
Along with Uber and Lyft, The We Company are unicorns. You thought a unicorn is legendary animal with one horn? Wrong. In the hi-tech lexicon, a unicorn is a privately held startup company valued at more than $1 billion. They get tremendous attention because they are new, cool, trendy companies that are in many ways changing the way business is done. There is no doubt that ride sharing has brought down the cost of transportation, helped unclog roads and democratized the cab business. WeWork has changed the office real estate market. These innovation companies are to be praised. But for investors, innovation without profits may make for a losing investment. Just like in 2000, when the narrative changes beware. We Company co-founder and CEO Adam Neumann told Forbes in 2017, “Our valuation and size today are much more based on our energy and spirituality than it is on a multiple of revenue.”
That may be great for subscribers of new age philosophy, but for investors looking to make money, remember that a stock investment is like you are owning that business. In order for the business to succeed it needs to make money. Period. Spirituality is irrelevant.
Just how much do profits matter when it comes to making an investment decision? Frank Caruso, Chief Investment Officer of US Growth Equities at AB, writes, “the long-term tendency of high-sales-growth companies to underperform those with high profitability, as measured by returns on assets. What’s more, our research shows that companies with the strongest sales growth are also the least profitable.”
It’s important to note that on many occasions the reasons companies go public is to raise more money. In the case of these unicorns who have sustained billions of dollars in losses, it can be like throwing good money at the bad. Giving them even more money to squander. Alex Wilhem wrote a fascinating article on Techcrunch about the public offerings of some of the biggest the names, like Microsoft, Google etc. In analyzing the Microsoft IPO he said, “The firm was profitable, had money in the bank and was not under pressure from external investors to go public. Essentially, Microsoft was the complete opposite of what we often see in the current tech cycle: unicorns limping across the finish line, nursing haircuts, thirsty for cash.”
Caruso concludes with an important investment lesson:
“Recent trends serve as a reminder for investors. Whether investing in a unicorn IPO or a publicly traded company, always look beyond the headline sales figures, as seductive as they may seem. And be wary of companies that don’t have real cash flows to support their top line. In our view, high and rising profitability, backed by solid business models, is the best formula for identifying investments with solid growth and return potential that can stand the test of time.”
Remember: Profits matter.The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc. or its affiliates.
Aaron Katsman is author of the book Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing (McGraw-Hill), and is a licensed financial professional both in the United States and Israel, and helps people who open investment accounts in the United States. Securities are offered through Portfolio Resources Group, Inc. (www.prginc.net). Member FINRA, SIPC, MSRB, FSI. For more information, call (02) 624-0995 visit www.aaronkatsman.com or email firstname.lastname@example.org.