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.
This is the argument of lost opportunity costs. I understand that an unprofitable company could have an extremely significant increase in stock price as it regains profitability but why risk it? There are good companies to invest in that are well-run. Some of those companies, I list on my Watch List.
If an unprofitable company that obviously does not have excellent management (or it would not be unprofitable) does not make a comeback and continues to hemorrhage money, then your investment could drop significantly. This is compounded by what you could have made from a well-run company.
Let’s do a quick example. Perhaps you invest in $10,000 in a company that is not currently profitable. Your theory is that the worst is behind the company and they are about to do much better. Your theory is that other investors will be impressed with this increased performance and make the stock price move up. These two combined theories contradict recent historical reality.
First, the company did not effectively react to events that caused them to become unprofitable. Why do you think that this is the time for them to get their act together and reverse this problem? What if you are wrong?
Second, the potential investors may not be impressed. What if the investment community wants to sit back and wait to see if the company can continue to be profitable? What if they wait for a quarter or two of continued improvement? It is not unusual for investors to wait 4-6 quarters before they believe that the company has fixed itself.
If one or both of your theories is wrong, your $10,000 investment could easily drop 10% in 6 months. Compare that to a good company that is simply executing like it always has and increases the stock price by 10% per year (or 5% in the same 6 months that you have been waiting). Your lost opportunity cost is not just 10% or $1,000, but is 15% or $1,500 of what it could have done in a well-run company.
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