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Watch: Does profit still matter?

Updated : December 18, 2019 11:29 AM IST

You’d think every business would want to make a profit.

But some of today’s most hyped companies are often unprofitable.

Think Uber. Or Tesla. Sexy names to investors, but their bottom line is less attractive.

Many of these loss making companies are often alluring to consumers as well. That’s because it means dirt cheap rides on Ofo, less expensive holidays on Airbnb, and a whole universe of music for the price of two coffees on Spotify.

There’s a saying that goes: revenue is vanity, profit is sanity. So, have investors gone insane?

Last year, three out of every four companies going public in the US reported a loss before debuting on a stock exchange.

The last time we saw a percentage that high was during the dotcom boom in 2000.

But if you look at the data over the past four decades, the average percentage is much lower, with less than 40 percent of companies being unprofitable when they go public. In 1980, just one in four IPOs was not profitable.

It’s clear the economy has moved on since the 80s. And if you need proof, just take a look at Amazon.

The e-commerce giant is the world’s second most valuable company by market cap, but it’s also known for being light on profits.

The company was founded in 1995, went public in 1997, and was unprofitable until the fourth quarter of 2001 - losing $2.8 billion in the process.

Its path to substantial profit has been slow, only really hitting the gas in 2017. Its profit jumped dramatically from the third to fourth quarter last year, surpassing the $1 billion mark for the first time.

It even hit a record high of $2.5 billion in the second quarter of this year.

But when you compare America’s largest companies over the last 20 years, Amazon’s bottom line is miniscule. Even when compared to younger tech giants.

Still, Amazon has made its founder Jeff Bezos the richest man in modern history.

His net worth is estimated to be more than $150 billion.

So why are shareholders backing companies that lose money?

A lot of it comes down to the growth of the tech sector. Tech is the fastest growing industry globally, and that phenomenon means investors are more comfortable with companies that tend to be unprofitable, at least early on.

Let’s get back to those companies that went public last year. Just 17 percent of the tech companies were profitable for their IPO. Compare that to 43 percent of non-tech companies.

These startups are kept afloat by venture capitalists looking for rising stars. They’re putting their money on fast-growing companies like office leasing firm WeWork, in hopes of the next big return.

WeWork made losses of almost $1 billion last year as it spent on rapid expansion. But it’s still valued at almost $20 billion.

In London, WeWork has become the biggest occupier of office space, second only to the U.K. government. Its nearly double that of Google, and much, much more than Amazon and Deutsche Bank.

That growth story helped it sell about $700 million worth of junk bonds, though the top ratings agencies classified them as junk. These bonds are considered riskier than their investment-grade counterparts, but they can pay off if all goes well.

Choosing between growth and profitability has always been the million-dollar question for companies, but venture capitalists lean towards growth.

That’s likely because the economy is progressively moving towards a winner-takes-all model, where a few big companies dominate market share and profits.

In 2015, just 30 businesses made up half of all public earnings in the U.S. Apple, Google, Amazon and Microsoft alone made up 10%.

But there are some signs that the market is recognizing rapid growth without profit may not always be healthy.

Chinese bike-sharing company Ofo grew aggressively with nearly $1 billion in funding from Chinese tech titan Alibaba. It went from having no bikes on the road in 2016, to operating in more than 20 countries, boasting roughly 10 million bikes.

The company is beginning to pull back from expansion, and is closing down or scaling back operations in countries like the U.S., Australia and India. It’s looking for - you guessed it - profitability.

One venture capital firm, Indie.VC is also disrupting the industry’s focus on growth, instead preferring to invest in companies which are firmly in the black.

The rise of unprofitable companies just wanting to grow market share can mean great deals for consumers.

But it could also mean greater corporate consolidation, as smaller companies can’t outspend large corporations, and venture capitalists with cash to burn.
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