This year is turning out to be an historical one for Wall Street and companies going public. There has been 173 companies that went public in the United States through the first three quarters of 2018. Of these companies only 17% of them actually made money in the 12 months leading up to the IPO. This high percentage of IPO companies “in the red” is said to be the highest proportion on record. So why are unprofitable companies choosing to go public?
Unprofitable Companies Have High Initial Gains
Investors are continuing to embrace those companies with negative earnings since it has shown to be a profitable investment strategy at least for the short-term. Unprofitable companies that went public this year have gained an average of 36% from their IPO price. Surprisingly profitable companies that went public this year only saw gains of 32% on average. The market has shown to sharebe more in favor of growth over profit.
Unprofitable Companies Have Greater Potential
IPO investors are only interested in a company’s growth and total available market. A company with steady increases in revenue each year can attract investors and raise capital by going public. This capital is then used to fund research and development on how to tap into a higher percentage of that total available market. Investors believe that most unprofitable companies could easily be profitable if they focused on just short-term earnings. Clearly IPO buyers are looking for those companies that invest their could-be profits into research, more employees and expanding their share of the total available market.
Amazon’s Unprofitable Business Model
The globe-spanning retail giant was an unprofitable online bookseller when they went public in 1997. Now Amazon is the 4th most valuable firm on the stock market which has gains of over 50,000% since its initial offering price. The company is notorious for having an unconventional business model of slow-burning and sustained growth. While this keeps profits at just a fraction of other companies it has put the online retailer in an unimaginable net.worth category. Amazon CEO Jeff Bezos has famously focused on expansion over profitability and it has resulted to becoming one of the most successful companies in the world.
Amazon’s success has influenced the growth over profit market in Wall Street. Unprofitable companies using revenue and expansion over positive net income as their main selling point for going public are hitting the market at historic rates. Next up is the unprofitable ride-hailing company Uber which has recently filed paperwork for IPO. While the company reported a lost of $1.07 billion in the third quarter it also showed an almost $3 billion revenue for the quarter and is supposed to be one of the most popular investments this year.
Why Unprofitable Companies Go Public
The main motivation for a company to go public is to raise money and spread ownership risks across a much larger group of investors. The decision to go public or stay private really has no regards to whether a company is profitable or not. The stock market has not seen this many unprofitable companies go public since the dot.com crash. This has some critics concerned that these investments will only work for the short-term and the losses will eventually pile up to cause a market crash. At the end of the day as long as a company is focused on growth with a large total available market they should consider going public. Investors have no problem in backing unprofitable companies.