I recently started a thread of discussion regarding why I avoid companies that are unprofitable. The topic is fairly long so I am breaking it up into several posts. You can see the first posting here.
One of the biggest reasons that you should avoid unprofitable companies is that it is indicative of a failure. It shows that the company has failed in developing and executing a plan that will keep the company profitable. I have never seen a plan that has a profitable company intentionally becoming unprofitable.
Let’s be clear, the issue is not an unprofitable company that is getting better (or approaching profitability). This happens on a regular basis especially for relatively young companies. In this case, I am talking about a company that was profitable and now is not profitable.
In every case of this profitability downturn that I have ever examined, the issue is always that factors turned against the company that the management did not prepare to overcome. These factors could be changes in the pricing of commodities, changes in economic situations, changes in competition, or many other changes. Regardless of the unforeseen change, the real issue is that it was unforeseen and the management did not take effective steps to anticipate and eliminate the change.
So why are you considering buying the stock? Did the board of directors swap out the management of the company? Did the board of directors swap themselves out? All of them are culpable for the bad decisions and lack of leadership. Why do you think they are smart now when they weren’t before?
There are companies that have better management than the money losing company. While past success or failure is not indicative of future success or failure – it is better than operating in a naive vacuum.
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