Currently, we’re living in an unusual financial situation. Each time there are more companies with negatives figures in their sheets balance. Something is changing.
How can we understand this market situation?
There are different kinds of investments. One of them is the growth valuation which is taking a lot of relevance nowadays. This kind of investment looks into the companies that can have future growing and omit the numbers in sheets balance.
On the contrary, value investor just looks into revenues, expenses and a lot of ratios. It’s completely the opposite face.
All of this is common in tech companies, due to its uncertainty companies. Today we know how the planet is working, tomorrow we don’t know how it will be going on.
But, why are tech companies unprofitable? It’s easy to understand. It’s because they expense all their effort in the development of the product and they invest high level of the revenues in marketing and sales. They are essential in tech companies and that can report future revenues.
I’ll use Uber as an example company to explain this situation. They spent in the Q2 2019 $1.2 billion in marketing, when the company earned $3.17 billion of revenues. That is to say, Uber invested 38% in marketing in the second quarter of 2019.
But, marketing wasn’t the unique expense for Uber. They also spent a great amount of money in development, administrative expenses and stock-based compensation when the company completed it IPO.
So, would you invest in a company with $5.2 billion of loss? Maybe yes, maybe not. In this case, Uber has important competitive advantages as to be the leader of the market or to have a great market share (69.7% in November 2019 according to Statista).
How to get the value of an unprofitable company?
For me, it’s important to keep in mind these metrics in order to know if a company can be a great invest opportunity.
- Revenue growth. Tech companies are creating new business model. Thus, investor should research if in a future the company will generate higher revenues to cover up its operating expenses. Can the company generate profits when it gets to be king of the market? If the business model is unsustainable to generate profit, maybe you shouldn’t invest in it.
- Gross profit margin. It is very related to the previous point. If you want to know if the company will generate future profits, you should know its financial structure. That is, looking into how much the company earns after paying operational costs. If the company has a little profit margin, we don’t consider it as an opportunity.
- Operating expenses growth. It’s important to look for companies which their expenses have a growing lower than the revenues. So, if the company improves its sales, we’ll know that the revenues will grow more than the expenses and it’ll able to have profit in the next quarters.
As conclusion, it can be said that it will be important to know the business and know how it generates revenues and how they spend the money. After that, you’ll need to do easy counts with simple metrics to check if the company is going in the correct pathway to profit.
It’ll be important to leave your value mindset and turn on your growth mindset. To wait a long-term and check if finally your idea was correct.