A colleague opens his MBA finance class by asking the students: “Who would invest in a company which reported 10 consecutive years of losses?” Some of the students wonder whether they are in the right class, and no hands are raised. The instructor continues: “Too bad, if you had invested in such a company, say Amazon or Tesla, you would have been a billionaire by now.”
As you will shortly see, the instructor’s case isn’t an aberration. In fact, investing in losing companies, as long as you know which ones to choose, is very lucrative.
But first, how frequent are corporate losses? Figure 1 shows the frequency of loss reporting in the U.S. and the EU+UK. In the U.S., during the booming decade prior to Covid, almost 50% of public companies reported annual losses (middle curve), and among high tech and science-based (pharma, biotech) enterprises the loss frequency was a staggering 70% (top curve). European companies (bottom curve) display a similar trend, though the frequency of loss is a bit lower: 35-40%. Booming economies, while roughly half of public companies are in the red? Welcome to the bizarre world of accounting.
Figure 1 shows that the loss frequency in both the U.S. and Europe starts accelerating in the 1980s. This isn’t a coincidence. The 1980s were characterized by a surge in corporate intangible investments: R&D, information technology, brands, etc. Whole industries, essentially intangible (without heavy physical assets) emerged in the 1980s and accelerated thereafter: software, biotech, internet services providers, to name a few. Moreover, enhanced investment in intangibles―the main drivers of innovation and growth―characterized practically all industries, as managers realized that innovation is the key to competition, long-term. In the U.S., the aggregate investment in intangibles surpassed in the mid-1990s the investment in tangible, or physical assets, and the gap is constantly growing. Enter accounting.