One way to show a profit is to change the definition of profitable.
It looks like we're headed for another dot-com meltdown. Despite all the hoopla about IPOs and unicorns, companies have to make at least a dollar profit to keep the lights on. This is an inexorable rule of financial law that cannot be violated for very long. Like a rubber band, the further you pull it back and stretch it, the harder it's going to hurt when it snaps back.
I'll go over this once again. These dot-com companies go through cycles about every 10 years. Private-equity investors invest in these companies which burn through cash in order to build a customer base and get big before regulators catch on and before competitors can move into their space. Then, they do an IPO which sells stock to little people like you and me, and in turn, investors can cash out their investment. Inevitably, most of these companies fail to make a profit, the stock tanks and little people like you and me end up getting crushed.
This is how the 1% gets Richer. They don't take our money away from us, we willingly give it to them. We actually begged them to take our money and think it's a privilege to invest in IPOs, not realizing that all we're doing is funding their dreams and crushing our own.
One of recent famous crash and burn stories in Silicon Valley has been Wework. Wework like so many other companies these days, really isn't a technology company, it's just taking some old-time thing and putting it on the internet and claiming it's high-tech. They basically buy or lease office space and then sublet it to individual tenants on an hourly or daily basis. Not real rocket science, here.
And of course it grew like topsy because they're renting out the office space at a loss, and many young gig workers needing a place to work, and are happy to find cheap office space for less than what they would actually have to pay for it. But of course in order to obtain the kind of growth they had, they had to hemorrhage cash. And in addition, the founders of the company were doing some insider dealings, using properties that they had owned personally - and even claiming rights to the trademarks and selling them back to the company.
But what really caused the whole thing to implode was when they tried to do an IPO. Since they weren't making any money, they had to put a good spin on things. So instead of talking about profits and losses they made up new terms or new metrics to measure the performance of the company. They called it "community profit" or something like that, and they claimed this term showed they were making a profit, but only if you used some sort of special standard based on "community values."
Unfortunately for them, regulators and accountants would have none of it. You had to have a balance sheet according to standard accounting practices. And if you didn't make money on a standard balance sheet then you weren't making money.
Sadly, though, there are other popular accounting practice terms that are often batted around which really are kind of specious. One of these is EBITDA or "earnings before interest, taxes, depreciation, and amortization." For some reason, a lot of tech entrepreneurs and investors like to bat this term around as if somehow you're making money before you pay your taxes and you're actually making money. Fortunately, the SEC doesn't recognize this term as meaning anything.
Why not make up a term called "EBAE" - or "earnings before all expenses"- which would mean your gross receipts, without deducting the cost of materials, labor, overhead, or any other expense. Under that metric, 99.99% of companies would be "profitable". As you can see, you are only limited by your imagination when it comes to accounting - as Enron illustrated. "Mark to Market" was another non-standard accounting practice that booked phantom profits before they were realized. Of course, putting debt off-the-books was another nice trick to play.
Another one of these companies that's hemorrhaging cash trying to build customer base is Lime, the scooter rental place. I'm very skeptical of this company because they're blowing a lot of money on scooters which end up in dumpsters. Not only that, the liability of all this staggering. People are renting the scooters and driving around without helmets in traffic and eventually one or more of them will get killed and sue the company. A class-action suit is inevitable.
In addition to all of that, many municipalities are getting tired of these scooters being dumped all over the place and are passing regulations outlawing or severely regulating these sorts of practices. Plus the whole thing smacks of a fad. I've seen people on vacation rent these scooters and they tool around in them. But after a while I think you will get tired of them, particularly on rainy days and in the snow. There's not a lot of room for growth outside of San Diego.
But, thanks to Wework, companies like Lime are now having to show a profit or at least hinting making a profit, so that investors keep plowing money into them. Lime is claiming that in certain select cities they will be making a profit, before taxes. In other words, they're not making a profit.
Lime came up with this new metric in their latest attempts to generate another round of funding from private-equity investors. Of course, if they were making a profit, they wouldn't have to be asking private-equity investors for more money. You would think private equity investors would figure this out. It's not enough to say that "Gee, in three cities we could be making a profit if only we didn't have to pay taxes.!" Because like death, taxes are inevitable.
This is why this EBDITA metric is also specious. They talk about earnings before interest, taxes, depreciation, and amortization as if somehow you can avoid paying interest or taxes. (Of course, that is one reason why drug dealing or any illegal business is so profitable - you don't pay taxes!) I'm sure if you looked at Sears' or JC Penney's EBDITA, it shows them to be quite profitable companies. Unfortunately they are staggering under a load of junk bond debt which is very difficult to service. It is this kind of debt which bankrupted companies like Toys R Us - not online shopping through Amazon, it is often reported by The Washington Post.
It is akin to saying that it would only cost you $500 a month to live in your house, but for the fact you had to pay off a mortgage. That might be useful information, but if you have $100,000 mortgage and no way of paying it off, it really isn't very useful information. You could argue that your housing expenses are only $500 a month, but it's really not true, is it? Particularly when the bank is foreclosing on you.
And that's what it gets down to - truth or falsehood. And it seems increasingly in the financial markets, people are willing to bat around falsehoods, because they make things sound a lot better. But when you lie to yourself - deny reality - it comes back to haunt you later on. And the longer you deny reality the worse it gets.
Market cap, as I noted before, is another one of these specious metrics. Another recent article online laments the fact that "a hundred billion dollars" in market cap has "evaporated" overnight in Silicon Valley due to the setbacks at Wework as well as Uber, Lyft, and other companies. Where did all the money go?
As I noted before, the money never existed. Market cap is another one of these specious metrics that is used to evaluate a company. It represents nothing, actually. For publicly traded company, basically it is the price at the last chump paid for one share of stock, multiplied times the number of shares outstanding. However, the majority of the shares - sometimes as much as 95% - were basically given to employees or to venture capitalists who paid very little for them in terms of cost per share. No one paid umpteen billion for Facebook, but the last sucker (you) did pay a lot for a share yesterday.
Another blogger, in relation to Bitcoin, illustrates how foolish "Market Cap" is, in relation to digital currency. The same analysis applies to stock prices:
"Remember, the formula is LAST trade price TIMES circulating supply. So if person A buys 100 Bitcoins for $10K each, then the Market Cap is $10K TIMES ~17 million coins = $170 billion. Then person B comes along and buys 1 Bitcoin (just ONE) for $10.2K. That TIMES ~17 million = $173.4 billion. The Market Cap has increased by $3.4 BILLION DOLLARS because ONE person bought ONE Bitcoin for an extra $200!!! Yes, really! This is how it works!"
In other words, billions in "market cap" can be created when someone buys one bitcoin, or even one share of stock, if there are a lot of shares or coins outstanding. There are over a half-billion shares of Apple stock outstanding. Every time the price of Apple stock goes up (or down) a dollar, its "market cap" changes by a half-billion dollars. It means nothing - only that someone bought at least one share a dollar more (or less) than before.
For privately held companies that are owned by venture capitalist employees with stock options, these numbers are entirely made up. Venture capitalists assign a number to the company, usually by using a dart board. They will claim that such-and-such a company is worth so much money based on how much money they plowed into it, or what they think the company is worth. But these numbers are basically pulled out of their ass, and are essentially meaningless - as WeWork's evaluation illustrated. Every day, we hear how some venture capitalist has "re-evaluated" the market cap (read: invented a new number for) of a company they are financing.
Companies that stick around for the long haul usually turn a profit and often pay dividends. But even then, companies are not forever. As I noted in my IBM speech posting, most of the Fortune 500 or Dow Jones Industrial Average companies from 50 years ago are no longer part of that average - or in fact, no longer exist. If you think about that, it's a scary proposition it makes you wonder why you're bothering to invest in stocks.
As Neil Shute wrote in his book Slide Rule, which was the story of AirSpeed, the aviation manufacturer he worked for, the people who initially invested in his company stock ended up getting their money back - many decades later after it was purchased by de Havilland. Those who bought and sold in the interim either made vast fortunes or lost similar amounts. The price of the company's stock went up and down with the whims of the market, and often not in relation to any rational evaluation. Like most tech companies today, the company rarely, if ever, paid dividends as profits were plowed back into more R&D to keep up with the rapidly advancing technology.
As Neil Shute wrote in his book Slide Rule, which was the story of AirSpeed, the aviation manufacturer he worked for, the people who initially invested in his company stock ended up getting their money back - many decades later after it was purchased by de Havilland. Those who bought and sold in the interim either made vast fortunes or lost similar amounts. The price of the company's stock went up and down with the whims of the market, and often not in relation to any rational evaluation. Like most tech companies today, the company rarely, if ever, paid dividends as profits were plowed back into more R&D to keep up with the rapidly advancing technology.
Today we see the same thing, only there is no technology involved. These new startup companies come up with a business plan and then try to flood the market and drive everybody else out and have a monopoly or near-monopoly business. It's a great theory, and with some businesses such as social media, it might actually work. Facebook is the dominant social media platform because they are. As Google illustrated with Google+, it's very hard to "me too" social media and take away even a small percentage of market share.
With other businesses such as renting out office cubicles or scooters, the barriers to entry might not be so high. And what's more, since these are very localized businesses, it might be very easy for a small competitor to chisel away at your profit margins.
The rise of these specious metrics I think is one thing that will cause the next recession. When people start talking about how profitable company could be if only they didn't have to pay taxes or pay back the interest on its loans, it's sort of pie-in-the-sky talk. These are actual hard expenses that companies have to pay. Hypothetical profits really don't keep the lights on.
Specious metrics and wishful thinking are sure signs that something bad is coming down the road.
