US Investment banks have launched various baskets reflecting investment styles and strategies. One of them is a “Loss-Making Nasdaq” ETF aggregating growth stocks that are registering accounting losses. These baskets have been shorted to hedge portfolios in the last months, creating extra volatility in these names . Many of them lost 30% of their market cap in May despite strong top line numbers and guidances. Many loss-making companies are not actually in the red, they are just constantly investing their cash in their business 

The Financial Times published last week a fascinating paper by Baruch Lev, a Professor of Accounting and Finance at NY University Stern School of Business: “Don’t be fooled by corporate losses”. He suggests that “loss-making” can be misleading and reminds us that investors that put money into 10-year loss-making companies such as Tesla or Amazon are now billionaires. In his words: “investing in losing companies, as long as you know which ones to choose is very lucrative”.

There are different types of loss-making companies as demonstrated by a fascinating academic paper co-written by Baruch Lev, Feng Gu, Chenqi Zhu: “All losses are not alike” https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3847359

According to Baruch Lev, some losers register accounting losses because of outdated accounting rules. High growth tech and biotech companies are constantly investing in their business. Investment in user acquisition, technology and patents is paving the way for future growth and is questionably reported as expenses. 

This somewhat reverberates with Jeff Bezos 1997 letter to investors:

❖   We will continue to focus relentlessly on customers

❖   We will continue to make investment decisions in light of long-term market leadership considerations rather than short-term profitability considerations or short-term Wall Street reactions. 

❖   We will make bold rather than timid investment decisions where we see a sufficient probability of gaining market leadership advantages. Some of these investments will pay off, others will not, and we will have learned another valuable lesson in either case. 

❖   When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we’ll take the cash flows. 

❖   We will balance our focus on growth with emphasis on long-term profitability and capital management. At this stage, we choose to prioritize growth because we believe that scale is central to achieving the potential of our business model.

An investment of $100 made in Amazon in 1997 would now be worth $165,000. Not too bad for investing in a loss making company. However, It was not for the faint-hearted. The Deshima Chart displayed in this blog plots Amazon share price maximum loss from previous peak. One had to resist multiple roller-coasters yearly drawdowns, including a 90% plus retracement in 2001. More importantly, “you had to know how to choose the right one”. Easier said than done.