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Why People Keep Investing in Cool Companies That Lose Money

If money is all that matters, a beautiful loser is still a loser,… But wait. IS money all that matters when we are buying unicorns (exciting startups)?

Recently, we’ve been looking at unicorns — those tech companies that are just so Now! that, like Uber, Airbnb, and DoorDash, they are part of our everyday conversation. But as Gary Smith and Jeffrey Funk have noted, they don’t make money. And seldom or never have. For years on end. The recent downturn could mean some don’t survive.

So Mind Matters News asked Dr. Funk, “Why don’t people notice, year after year, that these companies are not good investments? Is the buzzy idea more important than the financial outcome?“

Here’s what he told us:

There are many ways to answer this question. My favourite answer uses Nobel Laureate Robert Shiller’s concept of irrational exuberance. Some of the following words are directly from my 2019 paper in Issues in Science & Technology:

Shiller describes, in his 2000 book Irrational Exuberance, the drivers of booms and busts in stock and housing markets, cycles that occurred for stocks during the 20th century every 10 to 20 years.

During a boom, price increases lead to more price increases as each increase seems to provide more evidence that the market will continue to rise. The media, with help from the financial sector, supports the hype, offering logical reasons for the price increases and creating a narrative that encourages still more increases.

Rising prices for internet companies in the late 1990s, for instance, led many to believe that rises would continue indefinitely. At the time, the media were describing a New Age Economy of internet companies that would reorganize product value chains and create enormous new profitability for online businesses.

During a bust, the same thing happens in reverse, with a new narrative driving price declines that feed off themselves.

This irrational exuberance has been in full bloom for years, driven by rosy forecasts for AI and other new technologies by big consulting firms ($15 trillion by 2030). Similarly optimistic stories are told by by business schools and university PR departments, hyping their published papers.

Thought leaders such as Ray Kurzweil, Peter Diamandis, Kevin Kelly, and Erik Brynjolfsson provided intellectual firepower in their books, published 10 years ago. More recent hype comes from World Without Work (2020) and The Rise of the Robots (2016). The fiscal stimulus of the lockdowns sent this exuberance into hyperdrive. The narrative is changing, with many articles presenting a different view of AI and other technologies (Gary Smith and Gary Marcus for example), and some even pushing back very hard particularly on crypto and NFTs.

Nevertheless, the optimistic narratives still dominate the consulting firms, universities, and media. This won’t change until there is a bigger startup crash. And the crash may still be months — if not years — away because money from the stimulus is still there. One result is lots of dry powder with Vcs [venture capitalists]. Until Powell clamps down very hard with high interest rates, investments in risky startups, both private ($3.5 trillion valuations) and public ones, will continue, driven by a still overly positive narrative.

I am in direct contact with the optimistic narrative through my daily posts of factual articles, sometimes my own, on LinkedIn. I see so many ultra-positive influencers, many of which likely receive money from sponsors (I am offered money every few months). I also see pushback on my posts, with many people telling me I’m wrong, but almost always for no reason. I have yet to find anyone who can make a good argument about why these new technologies will diffuse. Their comments are usually something like: “People were initially critical about cars, computers, and the internet” and thus their favourite technology will diffuse. Clearly, these people have received a lousy education.

So unicorn investors may be looking at big names, not great numbers. And only a serious market correction will force another look at those numbers. And also looking at the fate of outliers rather than the fate of typical startups. Dr. Funk noted in 2019:

For more recent technologies such as artificial intelligence, a major source of hype is the tendency of tech analysts to extrapolate from one or two highly valued yet unprofitable start-ups to total disruptions of entire sectors. For example, in its report Artificial Intelligence: The Next Digital Frontier? the McKinsey Global Institute extrapolated from the purported success of two early AI start-ups, DeepMind and Nest Labs, both subsidiaries of Alphabet (Google’s parent company), to a 10% reduction in total energy usage in the United Kingdom and other countries. However, other evidence for these purported energy reductions in data centers and homes are nowhere to be found, and the start-ups are currently a long way from profitability. Alphabet reported losses of approximately $580 million in 2017 for DeepMind and $569 million in 2018 for Nest Labs.

Jeffrey Funk, “What’s Behind Technological Hype?” at Issues (Fall 2019)

Names and numbers aside, an economist once also said: Things that can’t go on forever won’t.

You may also wish to read: Warning: Unicorn stocks may be nearing bankruptcy, fire sales. Uber, Airbnb, and DoorDash seem so lifestyle-friendly … they even became part of our vocabulary. Jeffrey Lee Funk and Gary Smith warn that icons like Uber did not do much for their investors’ bottom line. Cool doesn’t necessarily pay dividends.

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Why People Keep Investing in Cool Companies That Lose Money