If an organisation is making substantial revenues this year but will not make any earnings in the future, it is useless in the eyes of an investor. But if it loses money this year and next year– and could lose cash for a few more years– it can still be very important in the eyes of an investor.
Amazon had negative earnings in 2012 and basically reported absolutely no net income this year to date. But it is worth $166 billion in the eyes of investors.
This is due to the fact that organisations are worth today value of future cash flows, not existing money flows, and certainly not past cash flows.
Amazon is not the only company that is plowing back all of its incremental profits into growing its company. This is very typical for enterprise software application business as well. Salesforce has made or lost a small quantity of cash every year for the past 4 years, however it has actually expanded its profits from $1.3 billion to over $3 billion in those 4 years. And its market value has gone from $12 billion to $32 billion in the same time frame. Day hasn’t made any revenues in the last 4 years, in truth the bottom lines have actually been enhancing. However, the stock has increased in the previous year and the organisation is now worth virtually $14 billion.
The lesson below is that you can’t just value a company by taking its existing performance into account– you should have a view to its future efficiency. You also have to understand why the company is not presently rewarding.
In the case of Amazon, it is making huge investments in warehouses and logistics to be able to remain to grow its selling company. Amazon is likewise making likewise huge financial investments in data centers to continue its growth in Amazon Web Services business. If Amazon did not desire to remain to grow, it can stop making those investments and start producing profits. If you think, as Amazon management does, that the future development is going to be there for Amazon, then you ignore the current revenue and loss statements and consider what a future P&L could appear like.
In the case of Salesforce and Day, they are making big investments in sales and advertising and marketing to secure additional consumers. They are likewise making considerable yearly investments in R&D to keep the market management of their existing items and bring brand-new ones to market. If you think that Salesforce and Day can remain to grow their revenues at or near their current development rates, then you neglect the current earnings and loss statements and think of exactly what a future P&L may look like.
Revenues are critical to the wellness of a business, however that does not mean a healthy company has to be presently profitable. An organisation requires to have the ability to be lucrative if it desires to be and it requires to be lucrative eventually in the future– at least hypothetically. So when you read that an organisation is losing money, do not review that as a bad thing. It might be a very good thing. Everything depends upon why.
This article initially appeared on Fred Wilson’s blog, A VC.