Why are so many unprofitable companies the best performing stocks this year? (opens in new tab)

I don’t know much about the stock market outside of throwing any savings I can muster into a vanguard fund, but articles like this remind me of the scene from Silicon Valley where the Pied Piper team is talking about finding a revenue stream.

Their investor, the Mark Cuban caricature, Russ Hanneman butts in and yells at them about the dangers of showing revenue and how it proves you might only be a 2x-er.

"It's not about how much you earn. It's about what you're worth. And who is worth the most? Companies that lose money!"

He goes on to argue that if you don’t show any revenue then the possibilities are left only to the imagination!

Pre-revenue = maybe a 100x-er at some point!

Obviously silly and over simplified, but I do think that there is truth in the humor. Once this company gets its act together, it could shoot to the moon!

Edit: Here's a link to the scene: https://www.youtube.com/watch?v=BzAdXyPYKQo

It is very simple. There are two things happening here. One: the Fed has invested trillions buying everything under the sun (not just t-bills) to prop up the markets and make it look the economy is fine. Two: interest rates are being held artificially low by the Fed and have been for a while. So people are desperate for returns and the only place to get it is equities.

It is a pyramid scheme and must pop someday. Really just depends on how/what/when the Fed does.

This analysis needs to exclude biotech companies like Moderna, otherwise it conflates high market risk companies that are burning money trying to become profitable with companies that are high on R&D risk and are practically forbidden from making money (from the general public) but are guaranteed an exit if the science works out (and will quickly fall to zero if it doesn't).

Given the 5-10 year time frame for devices and 10-20 years for drugs and complex therapeutics, most successful biotech companies IPO after phase 1/2 trials when they have zero revenue (it's illegal for them to charge consumers for anything related to the product until it's approved). Pharmaceutical companies have the benefit of knowing "product-market fit" ahead of time so a successful phase 3 is all but guaranteed a multi-billion dollar acquisition (it even happens at phase 2 for promising candidates). This has been going on for decades with increasing frequency thanks to the pharma industry falling off the small molecule cliff and analyzing these companies in the same group as VC subsidized rideshare or whatever isn't going to yield the best results.

"Almost one in five of these money-losing companies is up 100% or more this year. There are some huge gainers on this list including companies like Overstock.com (+1055%), Tesla (+429%), Peloton (+348%) and Moderna (+285%).

But there are also plenty of big losers of these money-losing firms. More than one-quarter of these stocks are down 10% or more this year while almost 50 names have fallen 30% or more in 2020."

So that explains it pretty well. You're basically making a VC shotgun portfolio out of the stocks with the exact same dynamics - the big winners pull the average way up and offset the large number of middling and poor performers. For a meaningful analysis, you would need to dig into the winning stocks specifically and ask why they're up so much.

This story comes up at least every week, plus more often if there is a stock crash, a big or techy IPO, the fed sneezes, or basically anything happens.

The reasons are always the same:

* the fed is printing money

* you buy FUTURE cashflow/price not current ones

* "profit" is taxed, so no company makes it if it can avoid it. That doesn't make their revenue is less than a expenses though (see also using share buy backs to avoid multiple levels of taxation).

* its often better for companies to spend excess cash than to hand it over (and thus let the government take 20 to 60% of it)

* idiots like buying shiney things and that includes shares sometimes

* the market can remain wrong longer than you can afford to be right (see for instance the last 20 plus years)

* if something has dropped 50% then gone up 20%, you'll hear that it's up 20%! In a pandemic/financial crisis/recession/whatever. Not that it's actually down 40% (that's right, 40% not 30%, that's how percentages work).

I'm not a business person so I'm mostly using my extrecatory organ for vocalization here, but...

One way to interpret this is that people are betting that losing companies are spending that money acquiring a resource that they can use to generate profit later. The obvious example is growing a giant userbase that will then stick with your product over time. Or it could be building up a bunch of infrastructure to reach a neccesary economy of scale. Hell, it could just be straight up paying lobbyists to buy politicians and do regulatory capture.

The implication from all of this, then, is that these businesses are directly aiming for and/or creating inefficient markets. In an efficient market, it's easy for participants to enter and exit, startup costs are low, and consumers can easily switch products. That means there should be nothing a losing company can buy today that would prevent a future competitor from eating their lunch a few years from now.

The fact that the market rewards losing company shows that there are things companies can buy now that stifle competition and reduce market efficiency in the future. These companies are spending money today to produce a worse market for consumers a few years from now.

That doesn't sound like something we should be thrilled about.

As a former equity analyst, I would say that it's probably better just to ignore this analysis then read too much into it.

The performance of company's stock isn't based solely on whether the company reported a net income it's previous year; it's based on (imo) an ever fluctuating list of metrics, both controlled by the company (i.e. Return on Capital Invested, which net income is a component of) and not controlled by the company (i.e. cost for banks to borrow capital, future growth expectations, current market valuation).

Small speculative unprofitable growth companies outside the major indexes are usually always the best performing stocks, because stocks in the same category are in the list of worst performing too. They have huge volatility.

The stock market is not rational, and it never has been, and 2020 is completely unprecedented with many overriding factors.

Interest rates have fallen so the equities market is the only place for returns. Meanwhile the Fed has promised to backstop and keep spending for years if necessary. Add in record amounts of trading from retail investors to institutional funds riding the volatility craze, especially the options market which has outpaced the underlying stock in for several companies, and there's an incredible amount of support for this bubble.

Unprofitable can be good or bad or unknown:

Bad: they dont have product market fit and cannot price at a level that is profitable

Unknown: they do have product market fit and can likely price at a level that is profitable, but choose to underprice to capture market share and grow

Good: They are actually profitable but are re-investing all their profits into internal investment to become even more profitable in the future. example: Amazon for the last 20yrs

Everyone thinks the stock market is crazy.

The government is crazy - printing trillions of dollars this year, plans to print trillions more. The currency is will be devalued, inflation will happen. Investors see that and are getting out of cash and into stocks/crypto/property.

So is the market really up, or is it just the outlook on the dollar is down?

The article quotes Ben Thompson (yes, from Stratechery) to explain why unprofitable stocks are performing well. It is basically what you might expect (they are re-investing profits in growth).

For those who wonder how you tell the good unprofitable companies from the bad unprofitable companies: typically you look at gross margins -- or unit economics. This is a little complicated to estimate for any sticky subscription company -- like a SaaS company -- you need to estimate the LTV and discount down to get the true gross margins.

Thompson's point is that a sticky subscription company can have enormous LTV.

The SaaS business model is just such a growth machine. If you have limited churn, expansion with existing customers, and sustained high growth you're going to be making a lot of money down the road. There's just so much lifetime value from SaaS customers and although the initial revenue is low per customer, it snowballs over time as more and more customers are added and services expanded. $CRM is a prime example of this phenomena.

It's also hard to use traditional metrics like EBITDA in a fast growing, expanding SaaS company. So much is based on future growth and revenues and getting over that hump to where the business becomes a raging cash geyser. Some will make it and some will not. But no one really knows who will make it and where they'll tap out today. For all we know many of these companies are unbelievably undervalued.

Additionally, I think there's a belief that there will be consolidation and many of these SaaS companies will be acquired. This has happened to an extent. Hell, the Mulesoft acquisition looks like a bargain today.

It's psychology-fueled. Also, a lot of companies reinvest profit so they don't have to pay taxes.

The stock market price != value of the company. Stock market price == PERCEIVED value of a company. All the stock market does is try and find a equilibrium between parties that want to sell a stock and parties that want to buy a stock. That is it. It doesn't do anything more. You could have a company that is bleeding money month-after-month, is foretasted to never make a profit ever, but if there are more parties (for whatever reason) that want to buy the stock than those who want to sell then the price will go up. The actual financial health of a company is utterly meaningless, the only thing that matters is what investors think of company.

I said this in another thread, and I think it's apt here.

If you have high growth, you can lose a lot of money and still have a good story.

If you make some money, but don't have high growth, then you can't tell nearly as compelling of a story.

Effectively, investors are assuming eventual profitability is inevitable, and measuring growth.

The 90s showed that's fair... sometimes. But definitely lets pathological corporate liars with juiced metrics slip through too.

There’s just too much money flowing around. Just the other day I read that Tim Cook managed to double both revenue and profits. Stock value increased more than five-fold.

The stock market is bloated. It will be interesting how we will get out of that again.

I'm surprised that Overstock is simultaneously still running at a loss and is seeing rising share values.

Every time I've tried to shop there, I've found a terrible selection, middling prices, and a mediocre UI. (To be fair, every e-commerce giant has a mediocre UI.) I see them casually mentioned in lists of "Amazon alternatives", but I've never once had someone recommend Overstock for a specific purchase. I don't think I've even talked to anyone who actually buys there.

Are they growing gangbusters in some niche I'm not aware of?

>Almost one in five of these money-losing companies is up 100% or more this year. There are some huge gainers on this list including companies like Overstock.com (+1055%), Tesla (+429%), Peloton (+348%) and Moderna (+285%).

Peloton was a great idea with equally good execution and everyone being stuck at home has only increased its value proposition.

Moderna is one of the leading companies in the pursuit for a COVID-19 vaccine, at least allegedly so.

Tesla is Tesla. EV megatrend yada yada

I don't know the first thing about Overstock.com to be able to opine one way or another

The volatility of the market makes for easy profits. Did an excercise on marketwatch in school one time. I traded random symbols that met my criteria and made a fat virtual profit. I kept it going after the experiment and realized the only reason I did well was because of the variability of that time for the market. I would kill to have some extra cash to invest right now/3 months ago, panicked laymen make investing easy.

This is a topic as old as time. I never get why people “complain” about what other people pay for things at a price they themself seem silly. It doesn’t impact you. It’s their money. If they feel they can have an advantage in the long term investing in companies at a high valuation, then sure

Everything thinks what they’re building is worth a lot of money but get jealous when they see high valuations from others :)

I wish more companies would separate the cost of _current revenue_ vs the growth investment of future revenue. I.e. Say it cost 30M to generate 100M, and 150M was invested in R&D and future sales. Even though it has negative revenue (100 - 150 - 30), the products that were sold are clearly profitable. Which imho is very different than saying the company is losing 80M a year.

If they are growing rapidly then that would be the primary issue.

Secondarily is a new kind of emotional injection from a wave of new retail investors. This happened in the .com when retail started in earnest with online trading.

And of course 'a kind of inflation'. The Fed is printing money like no tommorow, there's more money chasing fewer deals, very low interest rates. See: home prices.

Because the stock market is only secondarily connected to reality. It's primary function is as a mood ring for the collective mass of wealthy people. Wealthy people get a fetish for something and stocks go up. Right now they have a fetish for companies that lose five times their revenue while growing 500 percent a year.

"So the fear-mongering about companies with huge losses driving the stock market is misplaced"

Um... no. It would be great if you would come back to this article in 2 years time and run the same analysis on the same companies. I suspect the statement above will be rather invalid.

Put another way (by Jim Cramer):

For data warehouse plays, revenue growth + profit margin should be > 40.

In other words, you can focus on high sales growth to plan for future profits, but if your sales growth is lagging you should be turning good profits now.

My guess is that companies dumping have an advantage over legit companies, and they're growing much quicker when nobody is spending on normal companies anymore.

It's the inflated demand created by retail traders sitting at home . Most of them invested in the companies highly active in the media like TSLA, ZOOM etc.

Stocks are not supposed to necessarily value what a company is worth today, they are supposed to be speculative of what the company will be worth in the future.

The ads on that site made me give up on the article.

Also I see the stock market as a train that will take me through the dark tunnel of the inflation caused by printing all the recent money.

When we're printing trillions of dollars, you gotta put your money somewhere or you'll get negative returns.

Profit is not a very useful parameter for assessing a young company in growth mode with a good product.

Because their owners believe it is their last chance?

The market is jostling with too much magicked money?

Because of FED's QE

Don't most of these companies stand to benefit enormously from long term changes people think the pandemic will bring?

Telsa benefits from any environmentally stimulus.

Peloton benefits if we all move to more rural areas than downtowns and instead use them over a gym.

Moderna is a vaccine company. You are betting on them getting a big payout.

It's psychological, but it also goes from an understanding that profits, in the rigid economic sense, don't reliably exist.

A profit is gain realized by buying things, recombining them using innovation, and selling at a favorable price. A true profit is something you make, again and again, and with diminishing returns because prices move and the gap closes, as with arbitrages. Rents, which are more reliable, are payments you collect because you own things. (You may use those things, or you may, using the more common sense of the word, rent those things out.)

Most "profits" are actually just rents. Rents extracted because the company owns real estate, rents extracted because of brand presence, interest (which is a rent on money) through financing programs, rents extracted because workers' need for daily survival has them systematically underpricing their labor, and rents on political capital (favorable regulatory environment).

Getting paid because you have a great idea is intermittent, and usually requires taking on a lot of risk, and risk is something established companies hate. Getting paid because you own something is easy-as-shit and forever reliable. Where does the car industry make the bulk of its gains? Not on selling the cars, but in financing. It's an evergreen business, so long as there is capitalism-- there will always be people who need money they don't have, and it will always be an easy business to collect the vig.

Regular businesses eventually stop innovating-- they have plenty of smart people, but the bosses don't want to take risks because they're busy collecting personal rents by holding management positions, and obviously don't want to lose that-- and their "profits" converge to the rent roll on the resources they own. That's just how it works. Average equals mediocre, the latter used non-pejoratively.

That said, it's not sexy to imagine that one is investing into companies that have become mere utilities, that will continue to collect rents on the resources they own (of which a person can buy a tiny fractional share of the ownership) but not really do anything interesting.

These ultra-capitalist non-profits (non-profits-for-now) create the illusion that they're something different... that they're "rocket ship" companies run by people with supernatural talent and "vision", that they aren't rent-seekers using capital's native advantage over labor for reliable but unpulchritudinous gains... which is what all large companies are... but, instead, a kind of "new company" that is going to innovate moonshots and synergize us up a new century of prosperity, freedom, and magical puppies that never poop. Smart investors recognize that all of that is bullshit, and that these tech unicorns are just as exploitative as traditional companies (and, in fact, probably more so) but they also realize that dumber investors get the warm fuzzies and that there is therefore a premium.

So if I'm reading this right, the author feels that the reason these companies are so valuable is because it destroys the free market one customer at a time, selling lock ins that would crush a normal business to escape, and that will deliver long term value as a result of said destruction.

I guess that makes sense.