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Why are Unprofitable Technology Companies Worth Billions of Dollars?

Some of the biggest names in the technology industry have been making losses year in and year out, but their market capitalisation just keeps growing. Traditional investors who look at companies based on profits and how much cash a company can generate become vexed due to this.

Even major private corporations like Uber and Spotify have been able to attract billions of dollars in funding despite continuously reporting massive losses.

So how do these companies attract investments?

Ability to turn a profit

These companies, some of which with valuations north of a billion dollars, are able to gain an investor’s trust because they can easily turn their revenue into profits. The reason they continue to generate losses is because they have one eye on the future and are using the money earned to reinvest into new technology or expansions to stay ahead of the competition.

Companies that prove they can grow their top line and continuously stay ahead of the competition through innovative upgrades and purposeful reinvestments can justify to shareholders that they are using the capital wisely for growth.

Solid growth potential

Another reason that companies can attract investments to their business is a history of sustained revenue growth and the potential to enter new markets for expansion.

This is especially true for tech companies that leverage on the Internet for growth. The World Wide Web has enabled modern companies to expand at a rate unseen before. The increase of the e-commerce market, which has grown exponentially since the turn of the century, is a result of this.

The Internet allows companies to reach out to customers around the world seamlessly and with relatively little up-front cost as compared to traditional methods. Due to this, companies that rely on the Internet for growth have been investment darlings of late.

The Foolish bottom line

There are an astonishing number of technology companies, both private and public, that are not making profits but still carry extremely high valuations. Some of these may end up closing their doors eventually, but others can continue to thrive and be potential profit-making machines in the future.

Investing in these companies, however, can be a daunting task for investors as we will need to be able to weed out the wannabes from the real deal. And with traditional metrics like Price-to-Earnings or Price-to-Book valuation being redundant in such situations, investors need to use other methods to come up with a good valuation estimate to find out if they are getting good value for their buck.

Meanwhile, for more (free!) investing insights, sign up here for your FREE subscription to The Motley Fool's investing newsletter, Take Stock Singapore. It will teach you how you can grow your wealth in the years ahead.

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia doesn't own shares in any companies mentioned.