Why Profits Don't Matter

Posted by Ed 8 mths ago
Our lives increasingly involve products or services from companies that do not, and may not ever, earn a profit. As the Atlantic’s Derek Thompson recently pointed out, if you wake up on a Casper mattress, take an Uber to a WeWork office space, and have your lunch delivered by DoorDash, you’ve interacted with companies that lost a combined $13 billion last year.
If a company is losing money and still selling its product, someone is subsidizing it, and by extension, subsidizing your cheap rides and the beer at your co-working space. As it turns out, the person doing the subsidizing could be you. 
The reason these companies can stay in business is the money they get from investors—usually venture capital firms that fund startup companies. The investors hope to earn their money back when the firms exits—either through an acquisition by another firm or by going public.
It shouldn’t be surprising that when these negative-profit-tech-unicorns do go public, the price the market puts on them is often lower than what private investors thought they were worth. (WeWork’s aborted IPO last month being only the latest example).
Things like profitability, long-term growth prospects, and stable management matter to public investors. In theory they should matter to any investor public or private, but many investors in private markets face different incentives, and profitability is not high on their list.
 Fund managers—of sovereign wealth funds, endowments, and public pensions—are often judged by their ability deliver higher returns than the market average each year. This is especially true for public pensions, which manage the retirement funds of state and municipal employees.
For them, beating the market average is critical otherwise the funds must acknowledge they are underfunded. For years it was too easy for fund managers to promise future benefits without putting aside enough money for pay for them.
Because public pension funds estimate the cost of those future benefits using their expected return on their investments, their managers have an incentive to be overly optimistic in their return assumptions and to invest in assets with more risk.

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