We have been noticing a trend not unlike the one we saw during the late 1990’s market run-up: an increasing number of publicly-traded companies reporting losses quarter after quarter, while their stock prices soar. This disconnect of losing money – while enjoying strong stock appreciation – should have investors treading carefully in the 11th year of this bull market, in my view.
Here are some of the eyebrow-raising statistics that investors should be aware of:1
- Nearly 40% of listed companies in the U.S. reported losing money over the last 12 months. This is the highest percentage of loss-makers we’ve seen since the late 1990’s (and excluding recessions like 2001 and 2008).
- Of the largest 100 companies that reported losses, approximately 75% of them saw their shares go up over the last 12 months.
- Of all the money-losing companies in the U.S., 41% of them saw their shares go up last year. (Takeaway: smaller companies are not getting the same treatment as large-caps)
- Categorically, the largest percentage (42%) of companies losing money are in the healthcare sector, mostly in biotech. 17% of them are tech stocks, mainly the flashy IPOs like Uber and Pinterest.
Investors are placing a huge premium on disruptors and future growth, but the question remains – is it too much of a valuation premium?
Then There Are the IPOs
About 75% of IPOs last year were by loss-making companies, but I was encouraged to see that investors proceeded with a bit more caution in this space. In 2019, the class of IPOs underperformed the S&P 500 by more than 50% – a sign that investors aren’t getting too exuberant over the flashy new players in the market. It’s been this way for the entirety of the bull market for IPOs – over the last 10 years, the class of new companies that have listed are trading on average about 70% above their IPO price, trailing the S&P’s 190% rise over the same period.2
Investors can look at this market scenario in a couple of ways. On the one hand, we have investors skittish about flashy, high-growth but no-profit IPOs – a good sign that we are not seeing the type of exuberance that led to the tech bubble in the late 1990’s. On the other hand, we have an unusually large percentage of listed companies in the U.S. that are currently losing money, while the broad stock market continues to reach new all-time highs. Losing money while delivering rapidly growing sales and revenues is certainly an acceptable proposition, but the question is how long can it last and how high of a premium are investors willing to continue paying?
Bottom Line for Investors
Investors should proceed with caution and be mindful of the premium you might be paying for loss-making companies. Rising share prices have given many of these loss-making companies the ability to finance even more losses, which is a slippery slope particularly if we start to see a marked slowdown in economic growth. In the current environment, keep these two principles in mind:
- Statistically, over historical periods of time, we find that stocks that are expected to report positive earnings per share have generated higher returns than stocks that are expected to report negative earnings per share.
- In my view, the market is pricing many loss-making stocks on the expectation of future earnings growth. What we’re often left with are major assumptions about the business prospects of a company, as opposed to whether quarterly earnings are evolving (and growing) relative to expectations.
At Zacks Investment Management, earnings remain our core focus in portfolio management and investment decision-making. We have a long history of earnings forecasting with proprietary processes in place that help us monitor earnings and earnings estimates – which in turn drive our decision-making. With the bull market now in its 11th year, these processes will become ever-important, in our view.