How to profit from a loss-making firm
It might sound bonkers but you can make a fortune
HOW can you profit from investing in loss-makers? It sounds bonkers, but can actually be highly lucrative. Just ask investors in Amazon, Twitter or Ocado.
Taxi hailing app Uber was the latest loss-making firm to motor on to the New York Stock Exchange yesterday, completing one of the most highly anticipated US floats in recent years.
While its shares stalled from the $45 offer price, falling 1.2pc or $0.75 to $44.25 a few hours into trading, this still gave it a market value of about £62bn, putting it squarely among America’s listed giants.
But despite the enormous price tag, Uber has never made a profit.
Why would anyone plough money into a company that has never been out of the red?
‘When you look back to how some of Uber’s peers began, it wasn’t immediately obvious how they would deliver profitability,’ says John Moore, senior investment manager at Brewin Dolphin.
‘Yet the likes of Amazon and Twitter have found a way to do it, the latter getting there in the end after a particularly tough start.’
Rewards have been stellar for investors who took a punt on those loss-making companies.
An investment in Amazon as it floated in 1997 – when it made a loss of £23.8m – would have seen a return of more than 10,000pc today. In the first quarter of this year alone, it made £2.8bn – as much profit as in its first 14 years on the stock market combined.
Perhaps it is these successes which have fuelled investors’ appetite for loss-making companies. In recent months alone, Uber-rival
Lyft, mood-board app Pinterest and vegan specialist Beyond Meat have all drawn in money despite having never ended a year in the black.
It might seem crazy, but making a loss isn’t always a bad thing.
Neil Goddin, manager of the Kames Global Equity fund, explains that profit may not necessarily be the right way to measure a company’s potential, especially if it is losing money because it is rapidly scaling up or developing.
‘Arguably this type of company is using the stock market in the exact way it was meant to be used – as a source of cash to help build businesses,’ he says. ‘The real question is whether we believe loss-making firms will be successful in building a lead that will keep competitors at bay longer than other investors believe possible, like Netflix has.’
Disruptive firms such as Uber, which are shaking up an industry, may have to put in a lot of money to reach a size where they can make an impact.
Adrian Lowcock, head of personal investing at Willis Owen, says: ‘The types of companies which are listing at the moment need investors who can see their future potential and the profits that come from that, rather than focusing on the costs they are incurring as they build up the business.’
Although savers might be keen to get their money into the next big tech firm as soon as possible, it may be worth waiting a short time after the initial listing.
LOWcOcK
says: ‘ Share prices can be volatile following the launch as investors get excited by the chance to invest in a company for the first time, but this usually settles down after a while.’
He also advises savers to look at factors such as how fast the company is burning through cash, when it expects to become profitable and what threats it may face from rivals or regulation.
Most of these high-growth, highpromise companies are listed on US stock exchanges, although there are some in Britain, such as Ocado. Investors wanting to muscle in on the action can buy US shares directly through a platform such as Hargreaves Lansdown, though this often comes with extra fees. Alternatively they can buy into a fund which tracks the US stock market, or one which focuses on the tech sector like the Allianz Technology Trust.
But the growing willingness to put huge sums of money behind a business idea that hasn’t yet been fully proven has left some experts uneasy, while some parallels are being drawn with the dotcom bubble of the late 90s.
Goddin, however, says that ‘to say we are in a 1999-style blowout is maybe a stretch’.
And attaching high value to lossmaking companies needn’t sound alarms. Back in 1929, business machinery company IBM – now the computer giant – was one of the most expensive stocks on the US market while making a loss.
‘Like then, investors are increasingly interested in future profitability,’ says Moore.
The million-dollar question – perhaps literally – is whether lossmaking disruptors will be raking in the cash in five years or more.
Investors who can spot a good idea will be laughing, but with more trying to get a piece of the pie, pushing valuations higher, there is an ever-growing threat that unlucky savers could be burned.