Eli5: How can large companies be worth (valued at) so much when they do not make any net profit?

Question

Eli5: How can large companies be worth (valued at) so much when they do not make any net profit?

In: 7

Answer 1

They are worth what the investors *think* they’re worth at any given time. This is a big oversimplification, but:

I make a company whose goal is to build and sell time machines. I don’t have any employees yet and I don’t have any time machines, just the idea. I ask investors to give me money so that I can build some time machines and in return, they can own a piece of my company. If I am successful, lots more people will want to own my company and the investor will be able to sell the piece they own to someone else for more than they paid for it. This will make them money. They have to decide whether they actually believe other people will be willing to pay more money than they’re paying right now for a piece of my company. Most people think I’m crazy, but a couple of people give me a little bit of money for the pieces of my company ($10 for 1% each). In total, I’ve received $100 for 10% of my company, so my company is “worth” $1000. My company’s profit is $0.

20 years later, I have sunk a ton of my own money into the company, hiring smart people and buying pieces, and I finally succeed at building a time machine!! I announce this to the world, and investors go crazy. Everyone wants to own a piece of the time machine company because of course it’s going to do really well and will be worth even more in the future! All 10 of my investors sell the 1% they each owned for $1000 instead of the $10 they paid for it. My company is now worth $10,000. My company’s profits are -$1,000,000 (the money I spent on building the time machine)

So how much a company is “worth” isn’t really tied directly to profits at all. In real life, it often is somewhat, because if a company is already doing well and making money, it’s probably going to continue to do that in the future and therefore people will want to buy shares of it. But the only thing that directly determines the worth of a company is how much people are willing to pay for a share of it.