Everybody knows the story: in the first Internet boom, new companies rode high on staggering losses only to face bankruptcy once the music stopped. At the height of the madness, a single Internet startup lost $720 million in one year, but was somehow valued at $25 billion.
Now as companies invent arcane financial metrics to create a sense of profitability without actually being profitable, investors are again clamoring about “fundamentals,” the term they use for revenues and profits.
But the most fundamental measure of a company’s success is whether the sources of its profit — its customers — happily part with their money. Customers’ happiness tells you as an investor that the company is not merely profitable or unprofitable, but sustainable.
There’s a big difference. A company that makes money can still be unsustainable. HomeAway had a soaring IPO, but the customers who use its site to rent vacation properties hate it. This tells you that one day a startup like Dwellable or Rentmix is going to destroy HomeAway.
LinkedIn on the other hand eked out only $1.81 million in profit last quarter, earning money at about the same rate as Redfin did in June. But LinkedIn is worth $9 billion. That’s because LinkedIn’s earnings are very sustainable — and Redfin’s earnings are, admittedly, still very seasonal. No company will replace LinkedIn as a professional network anytime soon.
Investors’ inability to distinguish sustainable companies like LinkedIn from trendy dreck is what drives bubbles as well as crashes. We talk about crashes as the return of rationality but in reality crashes are just as irrational. Yes, the NASDAQ today is at only half of its April 2000 peak, but it’s at double its September 2002 low. The broad, multi-year bet that Wall Street placed against the Internet post-bubble was fundamentally the wrong bet.
Already, history has repeated itself. Remember the wildly popular 2007 video, “Here Comes Another Bubble”? It mocked PayPal’s Peter Thiel for insisting there’s no bubble. As evidence of the madness, it then cited the valuations of Facebook at $15 billion (now valued at $100 billion), Skype at $2.6 billion (just bought for $8.5 billion) and YouTube at $1.65 billion (the best deal Google ever made, with traffic and revenues that just keep growing through the roof).
A year later, Sequoia’s “R.I.P Good Times” presentation — which argued after the financial crisis that “a v-shaped recovery is unlikely,” and showed a picture of a Depression-era soup-line — was mostly a death knell for itself. Since then tech’s recovery has been nothing if not v-shaped, and Sequoia has missed out on an explosion of early-stage opportunities.
Now in 2011, the stupidest conversation we’re having is whether we’re in a bubble or not. Rather than trying to figure out whether all companies are overvalued or undervalued, we should think about which ones are using disruptive technologies to solve a serious problem for a large group of customers. Those companies are almost certainly not overvalued.
Take for example that company which lost $720 million in a single year. It had the dubious honor of being the most unprofitable Internet company in 1999, but it turned out to be the most sustainable business the Internet has ever created: Amazon. Post-bubble Amazon was trading at $7.19; today’s it’s trading at $209. Does anyone think Amazon is wildly overvalued?