Is there ever an appropriate time to invest in unprofitable companies?

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.

There are times that you will want to invest in unprofitable companies. However, this has to be done carefully and with a small portion of your investment portfolio, perhaps 10%. For this 10% of your portfolio, you can invest in more speculative offerings.  Some speculative offerings such as high-tech startups or biomedical startups typically have a fairly long run of being unprofitable as they work through their startup issues.

It is essential to analyze these types of companies carefully. You want to fully understand the business. You need to understand why they are still not able to create enough revenue to cover their expenses. Most importantly, you need to see that this gap is getting smaller rather than larger. You need to see that revenue is increasing and the costs of the company are being effectively controlled by excellent management.

Finally, you need to make sure that the future profitability event is from being well-run and not a Hail Mary pass that may not materialize. Counting on FDA approval of a drug when no other country has approved the drug, and it still has several rounds of testing to go, is not a safe strategy. Counting on a corporate takeover of an IT startup so that a large company can take advantage of “really cool technology” is not a safe strategy.

In other words, you need to be extremely cautious and very concerned about a company that is not profitable. It may have a significant path to profitability, but I suggest you are extremely diligent in watching its progress.

This is the last of my current series of posts on the subject of focusing on profitable companies to invest in rather than unprofitable ones. Personally, I stay away from all of the unprofitable companies as there are just too many good companies to watch. I don’t need the complication of trying to find that one company that is about to break out and be successful even though they were not successful in the past.

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