Does profit still matter? | CNBC Explains


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 U.S. 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% 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% of the tech companies
were profitable for their IPO. Compare that to 43%
of non-tech companies. These startups are being 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 bonds, although the top ratings agencies
classified them as junk. These bonds are considered riskier than
their investment-grade counterparts, but they can pay off if it all goes well. Choosing between growth and profitability has always
been the multi-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 scaling back or closing down 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. Hey everyone it’s Xin En.
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