How do you value a company that makes no profit?

How you value a commodity or a company hasn’t really changed since the 1700s. It all comes down to first principles. Profit versus debt, assets versus liabilities, how much you make and how much you have versus how much you take or need. But a lot of that falls away when you start looking at companies involved in cloud computing.

The BVP Cloud Computing Index tracks 44 companies with a combined value of $190bn. At least 31 of them are worth more than $1bn. But at the start of 2015, around half of them were losing money on a GAAP (generally accepted accounting principles) basis. Investors, it seems, aren’t so fussed about up-front losses if they can lean back and enjoy the subscription revenues.

So yes, the economics of software-as-a-service (or SaaS) have all sorts of sexy curves. But that’s only when everything works perfectly. Reminds me a little of the seduction statistic in Anchorman: “60% of the time, it works every time.” With meaningful valuations in mind – the real price of every thing – I’ve found myself returning to the magnum opus of one of my favorite Scots, Adam Smith.

The New York Stock Exchange had already been open for three years by the time he finished The Wealth of Nations in 1776. It built on the evolution of Venetian moneylenders who traded debt between one another in the 1300s, Belgian brokers dealing exclusively in promissory notes in 1531, and shares in limited liability companies set up to fund risky trading missions by sea, to a paper-based trade in shares of dividends from joint-stock East India companies.

The thing that nags at me is that in The Wealth of Nations, Smith describes the way a long-term understanding of value can lead to opulence (a grand term we can quite safely substitute for ‘wealth’). He discusses valuing companies that make profit from their goods or services; one way to generate high profit is to control supply of an in-demand commodity. But how do you value a company that doesn’t make sustainable profit? It’s a big problem.

When YouTube was bought by Google it wasn’t making a profit. For all that it helps Google’s other services, it still isn’t in the black. It’s one of many similar headline takeovers, trophy wives that are snapped up – and then propped up. And if they are not going concerns, are they truly financially sustainable? How is it safe is it to do business with them?

And whether it’s a cloud computing company or a content-sharing, social phenomenon, if it hasn’t made a sustainable profit in over a decade, then that’s ten years its technology has been ageing, ten years it has been becoming the new legacy system. I don’t see how companies like this can transform if they are also focused on returning money to shareholders.