I Have a Personal Problem Investing in Unprofitable Companies

It has been hard to ignore news about Twitter recently which went public on November 7, 2013.  It immediately went from $26/share to $40+ topping out $50.09.  It has since retreated recently (11/13/13 – $42.60) leaving me confused.  To date, Twitter has never made a profit.  Of course there are a ton of companies that aren’t profitable, but those usually don’t have a market cap of $23,000,000,000 (“B” with a billion) or if they once did they no longer do (cough cough Blackberry).

Call me crazy but when I am investing in a business through ownership of their shares I want that business to be profitable.  The clear downfall in this mentality is a lack of vision or being rewarded for a lack of vision when that business turns over to being profitable.

I think there is a compartmentalization going on in my mind which separates “investing” from “trading.”  As such, I have voted yes for plenty of unprofitable companies in my investment club, even suggesting some myself.

Going back to “investing” the first thing I do when screening for my dividend fund is to look for a P/E ratio of less than 20.  Since I am looking for a certain number Being that this number exists or is positive indicates that there are at least earnings

Don’t Forget Buffet’s Message in 1999

I recently started reading The Snowball an authorized Warren Buffett biography.  Before going deep into the Buffett family history there is a slice of history around 1999 when Buffett was giving a speech to the leaders in finance and business at Sun Valley. It was there he predicted the downfall of the tech bubble ending his speech with,

There was no new paradigm, he said. Ultimately, the value of the stock market could only reflect the output of the economy.

7 Responses to I Have a Personal Problem Investing in Unprofitable Companies

  1. Remember back in 1999 when everyone called Amazon, Amazon.org, because it wasn’t profitable for years? I can imagine a child running a lemonade stand unprofitably outside their house. Just because both businesses are not profitable, it doesn’t make them completely valueless.

    Facebook was also unprofitable for a long, long time. To apply your Buffett quote, the stock market has started to ultimately reflect their output to the economy.

  2. @LazyMan, today 14 years later AMZN has a Price/Earnings ratio of more than 1,300. I will give you a moment to absorb that figure, and the implication. Today, Facebook’s P/E is at 125. Do either of these companies look to grow their market share by 10x, or 100x, to fall in line with normal P/E profitability?

    Consider the capital invested to keep Amazon and Facebook going for so many years, and that currently capitalizes the “value” of the company. Do you consider this ‘efficient use of capital’?

    The market may ‘ultimately’ reflect the value of the output, just as it did for AOL, MySpace and Webvan. But it might be a long, long, long time. I’m with Evan on this one. There may be some short-term gambits that pay off but these companies are not something we can expect our grandchildren to inherit.

  3. I’m aware of Amazon’s crazy P/E. I wouldn’t touch investing in it. I’m pointing out that a company that didn’t have profits for years back well back in early 2000’s could still turn out to be a great investment.

    Hmm, I have Facebook at 100 P/E using Google Finance (https://www.google.com/finance?q=NASDAQ%3AFB&ei=KJiHUtg2yLSIApiiAQ). I can easily see it growing profits 3x or 4x to give it around a 30 P/E, which is where Google is today. It will take some time and the price might not go up for awhile while that P/E is coming down (making it not that good of an investment).

    I remember in some of the early days of Ebay it had a 2000 P/E and now it has a 25 one.

    It’s easy to throw out names like AOL, Webvan, and MySpace (was that even ever public)? It’s also just as easy to throw out names like Microsoft, Apple, and Google. I view Amazon, Facebook, and Twitter in the later group. I’m not sure that WebVan and MySpace ever got to be worth even 10 billion dollars (maybe WebVan as they had something like 4 billion in cash invested in it) and AOL had a dated product for years and years.

  4. @LazyMan, do you remember AOL purchasing Time Warner (not the other way around) in 2000? By 2002, TW posted a loss of $99 billion for the year and AOL stock was worth 10% of what it was just two years prior. Do you remember Quaker Oats buying Snapple, and selling it back for 5% of what they paid a few years later? HP bought Compaq? HP bought Autonomy and lost $9B on the deal when the true books were revealed? MySpace bought by NewsCorp? What makes Google a ‘good investment’ at a $1,000 share price and 1,300 p/e?

    The NASDAQ was almost 5,000 in 2000 and is still below 4,000 in 2013 after a huge runup. I’m not busting your chops (ok, maybe a little) but “the stock market has started to ultimately reflect (the company’s) output to the economy” is not accurate for unprofitable companies. Instead, “the stock market is reflecting the price a Greater Fool will pay for it.”

  5. I’m aware of all these. Google doesn’t have a 1,300 P/E, they have a P/E of under 30. I’ve owned Google shares since they were around $350 and I’m not selling them.

    Amazon has a 1,300 P/E and I said I wouldn’t buy it either. I just held them out as an example that has that many, many billion dollar valuation that didn’t have profits and now does have profits. The point was that all companies without profits don’t stay that way, and they often have reasons to justify that growth. Sometimes they are wrong (AOL) and sometimes they are right (Google).

    With Twitter, I don’t see it as a “Greater Fool” will pay for it. I see it as being a company that almost every big sports star, music group, company, and movie star is promoting. Are there any big consumer-facing companies not promoting their Twitter account? What other companies have that? Subway has to pay Michael Phelps for promotion. This is of huge value and I feel that over the next couple of years Twitter will turn the spigot on this firehose of potential profits. We’ve seen Google effectively do this with search and a small fraction of their other products.

    I’m not buying Twitter at $42 a share, but I was more than happy to buy in at $28 a share. Unfortunately, I haven’t gotten a chance yet.

  6. @LazyMan, it seems you are comfortable with your system, which is the bottom line. I do not understand HOW one can tell a “good” from “bad” investment, except in hindsight. Why is Twitter a good buy at $28, other than empiric evidence that the price is $42 a few days later? Why is Google a hold at $1,000, but not a buy or sell, other than the fact that you bought it at $350 (nice runup, btw)? ALL the companies have ‘reasons to justify growth’, but I’m not seeing the difference between random guessing and truly investing. Well, good luck to us all!

    re: Twitter, I would never buy it as I don’t see how it can ever be monetized. That said, if they ever find a way to spin off #BlackTwitter (which I believe to be 50% middle-aged white guys getting their Flava on) I’m in for at least $50K and don’t care if it ever makes money.

  7. Of course hindsight is perfect. However, if that was the only way to tell, we’d have to conclude that Warren Buffett is probably the luckiest man alive.

    There’s always a bunch of risk in investing in individual companies. Who knows if the company is like Enron, built on a house of cards? I invested in Palm as well because their webOS operating system was simply better than Apple’s in almost every way. Unfortunately, the company itself didn’t have the money to get the top hardware, couldn’t get the partnerships, had to sell to HP whose business people completely bungled just about every conceivable business deal possible (you mentioned the Autonomy one, which is nothing compared to how they handled webOS).

    In the end, it’s largely a gut call on my part. I saw Google with a marketcap of somewhere around $100 billion and Apple with a one of $500 or $600 billion. I asked myself which business I’d rather own, and it was Google not Apple. With Google you get many more leading businesses (top email, top mapping, top advertising, top search, and at the time the second and growing mobile OS). I’m sure I’m missing a lot of what Google does, but I just liked that business more than Apple’s. Of course, I like Apple’s current P/E (and pile of cash) now that it’s gotten cut down from the 700s.

    Anyway, when I’m looking at Twitter, I’m not necessarily caring about profits right now. I’m trying to project at what seems to be a fair market cap for a business of its impact. At $28 it would have been around a $15 billion company (I think), but at $42 it is around a $23 billion dollar company (I think). Obviously the lower price is better, right?

    I’m hoping the buzz wears off and it drops back into the mid 30s. Then I probably swoop in and try to bargain hunt it. It worked with buying Facebook around 19-20.

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