In the late 90s, financial writers fell all over themselves explaining how we had entered into a “new economy” in which blase factors like corporate profits no longer mattered. No sir, not in the new economy. It was all about users, and growth potential, and innovation (though innovation toward exactly what was never made clear). Veteran investor Julian Roberts, who had made his clients hundreds of millions of dollars investing the “old way” was excoriated for daring to refute the correctness of these new notions, branded a has-been and an old man who needed to sit down and shut up.
Then the Tech Bubble burst. And financial writers (yes, the same ones more or less) spent the next decade talking about how silly it was to give stratospheric market valuations to companies that had yet to decipher that most basic of codes: how to make a buck.
But you know, history does that whole repeating thing. Amid the rise of companies like Google and Apple there were others which were wildly popular with the consuming public, but had not yet figured out exactly what they wanted to be when they grew up. But they had potential (every one said), so the shares went charging higher.
Recently, a couple of notables have moved back toward Earth. Turns out Twitter and Yelp haven’t quite figured out how to make enough (at least not so far) for their shares to remain in the land of way-over-valued.
Twitter is bringing in pretty good revenues, but it’s spending even more. In addition to the financial loss (which analysts were predicting, by the way), the future of user growth appears in question (also not new news). As for Yelp, the user base is on the wane and they’ve now had 4 bad earnings reports in a row; not to mention the departure of a couple of high profile board members. This stuff didn’t happen over night. The lack of money making has been going on for a long time. The current investors who watched a big chunk of their investment evaporate this week could have gotten out at any point over the last few months.
Here’s an interesting game you can try: go to your favorite stock screener (Yahoo’s, for instance) and do a search for the companies with the lowest market caps you can find. You will see a bunch of gold mining companies. Or at least companies which were formed for the purpose of mining for gold, probably back when gold was worth nearly twice what it is today. See, there are places all over the world where gold is known to exist. It’s just that the concentration is not high enough to make it worth the cost of running the equipment necessary to get it out of the dirt. The odds of doing it profitably go up if gold is worth $1900 an ounce. A lot less so at $1100. So these companies have all been wiped out, again for that most basic of reasons: they didn’t make enough money.
If you stood up in front of a bunch of stock investors and said the words, “You know, it’s important for companies to earn a profit,” you could probably expect some arched eyebrows and maybe a derisive comment or two. “No kidding?” someone might remark. It seems like such an obvious thing. And yet, time after time we see the market run up the value on some company that doesn’t make enough money to justify that value; and sometimes doesn’t make any money at all. So maybe it is worth pointing out, after all.
There have certainly been cases of companies finding their footing and driving the dollars to a sufficient degree to catch up to the valuation. But an awful lot of stocks have failed as investments, too. The vast majority of them had at least one problem in common: the company didn’t make money.
Seems to me that if you are holding the stock of a company that doesn’t make money, you have to ask yourself why. Because money, matters.