Fourteen companies in the S&P 1500 and S&P Completion Markets recently made waves for the wrong reasons. They all recently posted massive losses and, in the process, lost massive amounts of their investors’ money.
These popular companies, including Uber Technologies (UBER), Rivian Automotive (RIVN), and Carnival (CCL), posted massive losses this year to the tune of $1 billion or more. Other companies in the group of 14 included crypto exchange Coinbase Global (COIN), Peloton Interactive (PTON), and the free trading platform Robinhood (HOOD). Investors.com. Shares of the 14 companies are down an average of 60% this year to the detriment of investors.
Investors in popular companies like Uber, Rivian, and Robinhood could have avoided investment losses by asking one simple question:
Is the company profitable?
It’s a basic question most investors fail to ask before entrusting their capital to a particular company. Instead of asking relevant questions, investors often go with their emotions or what’s popular or buzzworthy instead of asking relevant questions. It’s basic human nature, but these human behavioral biases prevent investors from asking the hard questions that prevent them from making bad investment decisions.
Behavioral biases are actually encapsulated in a fairly new field of behavioral science called behavioral finance. There are hundreds of books written on the subject. In his book Behavioral Investor, Daniel Crosby contends that “too many investors neglect their process and get overly excited by a stock pick they read about on their favorite financial website, or, probably worse, that they hear about from a friend or someone they respect. They don’t do their own full diligence and wind up getting lucky or burned. (“You can be right and still be a moron” for making a poorly thought-through decision, according to Crosby.).”
Asking the right questions is an effective way to overcome behavioral biases.
Mainstream investors are often too willing to let emotions rule their investment decisions. On the other hand, smart investors like ultra-high-net-worth investors (UHNWIs) take deliberate steps to prevent emotional investing. Instead, they treat their investment like an acquisition of a business, essentially an equity investment.
Instead of relying on emotions and hunches, smart investors rely on numbers, data, metrics, and fundamentals. Why do smart investors rely on data and math? Because they want predictability, reliability, and consistency. Building wealth for them is like constructing a structure brick by brick. They want to know they can rely on each brick to build a strong structure. Speculative investments make it hard to predict the reliability of the individual components, which compromises the whole wealth-building structure.
Smart investors want to account for all variables, unknowns, and circumstances. They don’t want to leave anything to chance because a miscalculation can mean the collapse of the entire financial structure.
Asking whether a company is profitable is just the beginning of the analysis process, but it’s an important first step that should eliminate many options from the get-go.
What other questions could you ask to make sound investment decisions?
So, if you were acquiring a business, what basic financial questions would you want to be answered about the business besides its profitability? You could delve into the substance of its profitability. What makes it profitable? For how long has it been profitable?
Here are examples of questions to ask:
- How long has the company been in business?
- How long has it been profitable?
- What has been the financial performance of the past 1, 3, and 5 years?
- What are current revenues, expenses, and net operating income?
- What are the financial projections for the next five years?
- Anything in the market or business model that would potentially disrupt financial performance?
These questions are important to ask when evaluating a business, and they’re equally important to ask when investing in a company.
The numbers and metrics are important because the amount a smart investor is willing to pay for an investment reflects what they think their share of the company is worth over time. Knowing the company’s historical and present financial performance can be extrapolated to predict future performance.
Smart investors also want to know when they can expect to recoup their investment. Why? And here is an important distinction between UHNWIs and everyone else. They want to know when they can recoup their investment so they can put it into another investment to multiply their income streams. They’ll keep their first investment active, but with their recoupled funds, they’ll parlay it into another investment.
Smart investors ask the vital question of profitability because it’s fundamental to investment success. After all, the economic fundamentals and metrics like supply, demand, income, and macroeconomic factors like employment, household income, and other economic indicators are the best predictors of success. It’s not what the herd buzzes about or what’s hot on social media.
Smart investors take emotion out of investing to avoid investing in unprofitable companies. It’s something every investor can learn from.
Kyle Jones is a co-founder and Key Principal of TruePoint Capital, LLC. Kyle is responsible for the company’s strategic planning, investment decisions, asset management, and overseeing all aspects of the company’s financial activities, operations, and investor relations.
Kyle obtained a Bachelor of Science degree from Texas State University – San Marcos, where he also played Division 1 Baseball.