Why companies that lose money can still be successful

Believe it or not, profitability isn't always the most important factor.

Disclaimer: I am not encouraging anyone to buy any specific stocks with this article. Please do your own research before making investments.  

Last year, I saw a LinkedIn post that I thought was hilarious. I didn’t screenshot it and there’s no way I can go back and find it at this point, but I do remember what it said. Uber’s stock had gone down and the person said something like this:

“This shows that companies need to be profitable in order to be successful.”

I thought it was funny because this random guy on LinkedIn was acting like he cracked a code that no one else had figured out. It was almost as if he expected someone who had invested in Uber to read the post and say, “Damn it, companies are supposed to be profitable?” and then sell all of their stock based on this crazy insight. 

Now look, I don’t own stock in Uber, but grouping together every unprofitable company is just lazy. After all, Elon Musk is now the world’s 7th-richest man, above Warren Buffett, and Tesla spent years burning through cash. I don’t know what that guy on LinkedIn is doing now, but I really hope he’s reevaluating his opinion. Anyway, let’s talk about why unprofitable companies can be successful.

Why unprofitable companies have value 

A little bit of basic information here: It’s important to remember that stocks are priced based on present and future earnings. So if a company is unprofitable now and it’s going to be unprofitable forever, it’s worthless. On the other hand, if a company is unprofitable now but is going to make a lot of money in the near future, then it’s a valuable company. 

There are plenty of examples of successful companies that weren’t profitable for very long periods of time. The most famous example is probably Amazon, which was not profitable for the first 6 years of going public. Jeff Bezos was reinvesting revenue back into the business to make sure that Amazon had greater selection and more convenience than any other retailer. Instead of focusing on short-term profits, he was focusing on growing revenue and improving the business.

Now, Amazon is a $1.5 trillion company. The platform’s got the best selection of products in the world, 1-day delivery, and a very profitable cloud computing business. All of this took years of effort and investment. If Bezos had only been focusing the business on generating profits, there’s no way he could have built the company into the giant it is today. 

Of course, not every business can follow this strategy. As this article makes clear, Amazon was different because it was trying to grow as fast as possible, dominate the eCommerce space, and get customers locked-in when the Internet was still young and there were very few competitors. It wouldn’t really make sense for a company in an established industry to do the same thing.

Here’s when unprofitable companies screw you

Obviously, not every unprofitable company is like Amazon. There are also companies like WeWork. Like Amazon, WeWork was also focused on growth. Unlike Amazon, it completely fucked everything up. 

If you’re not familiar with WeWork, they’re a company that leases office space, renovates the space to make it friendly for startups, then rents it out to companies who are just starting out. A year ago, WeWork filed to go public. The company was growing fast, going from 1 location in 2010 to more than 500 in 2019. Now, it looks like the company is on the verge of bankruptcy. 

So what happened? As this article by Aswath Damodaran points out, WeWork’s business model has some real problems. Real estate is already a business that gets hit hard during recessions, and WeWork had pretty much set itself up for failure. If a recession hit, chances are most startups would fail and WeWork would be left with tons of debt with zero tenants. This problem would still be there no matter how much WeWork grew. 

There’s a lesson here: It doesn’t how much a company grows if the underlying plan doesn’t make any sense. Throwing a bunch of money at a bad business model doesn’t suddenly convert into a good business model. So before investing in any unprofitable company, it’s important to think about whether their long term plans actually have a chance of creating a sustainable business in the future. 

How our human biases can hurt us

But a potential WeWork situation isn’t the only problem with investing in unprofitable companies. We also have to be aware of our biases when it comes to predicting the future.

I invest in Spotify, a company that’s had trouble being sustainably profitable in the recent past. In the past three months, Spotify’s stock has gone up by 111%, which makes me feel good when I open up my Robin Hood. 

But who knows, maybe I’m just blinded by my bias. If the huge bet that Spotify is making on podcasts doesn’t work, then their stock is currently overpriced. In 2018, the podcasting market was only $478 million. While most people are expecting that number to grow, human beings always assume the future is going to closely resemble the present. 

Right now, podcasting might be the most exciting form of media around. It seems like everyone wants to get in on it. I’m sure many of us have heard multiple friends talk about their plans to start podcasting in the past couple of years. But maybe we’re blinded by our present bias and the market isn’t going to be as big as Spotify thinks.

Personally, I think podcasting is going to be a huge opportunity, but I’ll let you guys know in a couple of years how that investment works out for me. 

The moral of the story 

Before you invest in an unprofitable company, you should do your research and proceed cautiously. It’s easy for someone who’s investing in an unprofitable company to point to successful companies like Amazon. But that’s ignoring all the failed eCommerce companies that flamed out early. 

If someone doesn’t want to buy the stock of any unprofitable companies at all because they want to avoid risk, I don’t think they’re making a bad decision. I just hope they’re not making bad posts on LinkedIn.

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