Money to burn

 

According to research from the University of Florida, Twitter, which lost $79 million in 2012 and is poised for a bigger 2013 loss, is hardly alone in losing money as it prepares to go public. The University estimates that 68 percent of this year’s IPOs were also losing money.

After all, based on their history, there is no basis for concluding that these unprofitable companies will ever make money.

That’s the stock in trade for a company about to float whilst losing money. If it were making a profit before its IPO, it would be harder to make bullish forecasts about how much profit the company will generate in the future.

Ironically for a company losing money, the sky’s the limit when it comes to predicting how bright its future revenues will be.

In tandem with the ability to forecast a spectacularly profitable future is the functioning of one of the market’s most basic laws: momentum. In other words powered by its own performance a stock that is gaining value up will continue to appreciate in value just because it is going up.

More specifically, when there is no real positive cash flows on which to value a stock, its price will rise because investors who do not own the shares will want to climb aboard the bandwagon rather than miss out.

This wave of “new buying” can help to drive up the shares further, which will attract a new buyers creating a dangerous bubble.

It would probably be a more prudent strategy to avoid the money-losing IPOs and invest in companies who are making a profit before they try and float their shares.

However forecasting the price of stocks remains an inexact science and unfortunately for the investor there is as yet no failsafe basis on which to explain why stocks go up and down.