Why are companies that never make a profit so well valued?

Question

I'm trying to understand something that seems highly counter-intuitive. For-profit companies exist to turn a profit. I know that a company might run negative early on, but people who believe in their business model (i.e. venture capital) will often step in with money for a piece of the future pie. But at some point a company has to be able to turn a profit to survive. Yet, there are some companies that have never turned a profit, and seem unlikely to do so, and yet they seem to be relatively well valued.

Exhibit A here has to be Uber, which has been around for 10 years, is a highly valued company and trades its stock fairly well. It might even be worth $90B. Yet it turns no profit

Uber’s revenue in the fourth quarter of 2019 grew 37% to $4.07 billion. However, it reported a net loss of -$1.1 billion compared to a net loss of -$887 million in the same period last year. EPS was negative -$0.49 compared to -$0.52 expected.

Full-year 2019 revenue grew 26% to $14.1 billion and net loss was -$8.5 billion compared to a net profit of $997 million for 2018. Stock-based compensation was $4.6 billion in 2019 for a net loss of $4.1 billion and adjusted EBITDA of negative -$2.73 billion.

In 2017, Uber posted similar losses at $4 billion.

There's also some open questions about how their business model works

Or consider Uber. The application is supposed to reduce drivers’ downtime by efficiently matching riders to drivers. In places where you would ordinarily have to phone for a taxi, the app technology probably does provide real, large advantages. In practice, there are a lot of places where technological matching is less efficient than in-person matching, especially airports, where inefficient Uber pickup has led to increasingly clogged access roads as drivers search for specific passengers instead of picking up whoever they see at the front of the line. Unfortunately, these places where the app is at a disadvantage compared to traditional taxi hails tend to be the places where demand for transportation services is highest: A key driver of Manhattan’s increased traffic congestion over the last decade is passenger-less Uber drivers, moving around looking for fares. And if Uber’s technology is so good at matching drivers and riders and capturing the variation in customers’ willingness to pay across time, why has the company had to repeatedly resort to paying drivers more than it collects from customers in order to ensure that enough of them are around at peak times?

I feel like I'm missing something here. Why would people clamor to invest in a company with no profits?

Answer 1

The short answer is because they expect the company to make profits in the future and they expect those future profits to be large enough to justify the current stock price.

A company like Amazon, for example, spent many years without generating particularly large profits because they kept re-investing any revenue to grow the company. In recent years, though, it has started to report pretty significant profits. If the company is able to continue growing its profits as a mature company, that would potentially justify the current stock price (and the historical stock price).

Of course, it's also possible that any given company will turn out to be more like pets.com than Amazon and the current stock price is a bubble that will pop when reality intrudes. That's one reason that investing in high growth companies is generally riskier than investing in mature companies with established profits.

Answer 2

Agreed with Justin Cave's answer. Besides expectations, I'd like to add that many companies are very well valued because of good marketing, media, herding effects, speculation, and general optimism about the market. In many cases people buy a good story, not black ink in the bottom line.