No Profit IPOs – Risky Investment
Risk is usually rewarded, right? Not always when it comes to public companies. Don’t invest without truly understanding the ramifications.
Can you afford to lose your money by investing in a company that is not profitable? Uber lost over $51 billion dollars in market capitalization in one week and has lost more in dollar terms that any other IPO since 1975!
There have been a lot of companies going public without profits lately, as many as in 2000 which was right before the dot com bubble burst.
So why does a company go public without profits? Mainly it’s to access investors’ capital for future expansion. Investors clearly are not buying the company for their profits today but rather for the future appreciation of its stock. And that only happens if they invest wisely.
Investors like you and me cannot get a piece of the Uber or Lyft IPO stock. We must buy at the listed price when it is traded on the exchange.
So now you cannot wait to rack in your gains as any IPO is hot and they always rise in price. But before you activate that e-Trade account and liquidate your savings and risk it all, you need to better understand a few items about IPOs, market prices, investing theory and investing in companies with no profits.
Failure to understand these could result in big losses for you.
IPOs Are Priced Below Expected Trading Price:
This usually gives the IPO holders and instant gain pop for taking the chance of losses before a company trades on an exchange. IPO holders also have stock restrictions to stop holders from flooding the market to realize an instant gain. If allowed, this would increase volume on the market and decreases prices (exactly the opposite of what an IPO company wants).
The market price that you will buy at considers supply, demand and all market information in its price. There’s nothing hidden here for sophisticated investors because they have poured through the offering statements to assess the company before buying.
Investing Theory:
Modern portfolio theory considers both risk and return to create what is known as an efficient frontier. This identifies the amount of return required to compensate an investor for taking on certain levels of risk. Diversification reduces risk and is a key factor in creating portfolios. Pouring a lot of money into one company is risky and you lose the benefits of diversification by doing so.
Investing in Companies with No Profits:
You are buying into their future and their ability to invest market capital wisely and grow. Understand that many companies intentionally invest heavily in their future. That may cost them losses today but may result in market-share gains tomorrow. The best example of this is Amazon, which has a history of losses but has invested heavily to gain a large share of the online consumer products market. Now Amazon is the largest online retailer in the world – but did you know that Amazon Web Services is its most profitable product line.
Uber and Lyft both recently went public and neither has ever made a profit – despite destroying the taxi industry. Investors are buying into the future, namely driverless technology and the ability to provide taxi and delivery services without humans. The gamble here is whether the technology works, if consumers trust it and if the company can execute and monetize their profit strategy. A misstep in any area could mean failure. It is a high-profile product that has its own independent contractor workforce but the price is very cheap and is a win for consumers – not for investors. This is risky indeed.
So don’t just invest in a vacuum and fall into the e-Trade trap that has you blindly believing you can make investments gains when the professionals couldn’t. Would you perform brain surgery on your child if you were not a surgeon? Didn’t think so. So why do you think it will be easy to outperform trained investment professionals in the stock market?
Think long and hard about investments. It is easy to get caught up in the IPO hype but the savvy investor critically assesses the upside and future prospects of no profit companies.
Sources:
https://www.nytimes.com/2019/05/15/technology/uber-ipo-price.html
https://www.vox.com/2019/3/6/18249997/lyft-uber-ipo-public-profit
