The rise and fall of the ‘unicorn’ – and the importance of portfolio diversification

Goldex Team

Editorial content

Plummeting value

When Adam Neumann, then CEO and founder of office space start-up WeWork, filed the first papers which would put it on the road to IPO, his company was valued at an astonishing $47bn. That was on August 14, 2019.

Just a few weeks later, after revelations in those papers triggered multiple investigations into the company’s finances and leadership, that valuation had plummeted to just $5bn. On October 22, Neumann left as CEO (with a $1.7bn payoff) and the IPO had been put on hold indefinitely.

The company is currently undergoing a rescue plan led by new owner SoftBank, and how its story will end, nobody knows. Mass redundancies and a reshaping of its business to focus on profitable markets are both expected. On November 14, the New York Times revealed that it lost $1.25bn in just one quarter of 2018.

The value of valuations

Investment trends come and go. Ask anyone who was around for the original dotcom bubble and its fallout. But many lessons have been learned since then, and many fortunes made. We all know how much money can be made from digital start-ups if you choose the right one. Just ask anyone who chucked a few hundred dollars into Google’s first funding round.

So it’s easy to see why giving a start-up a massive valuation, without it making a penny of profit, has become just the way things are done. But the rise and fall of WeWork is just the latest cautionary tale that there’s no such thing as a sure thing. It’s vital to see beyond the big numbers and vast valuations to what’s actually going on in the boardroom.

Cautionary tales

The most notorious example of an overblown valuation is probably blood testing company Theranos, valued at $9bn in 2014. Its value in 2019? Zero, after its claims to have found a way to test tiny amounts of blood accurately were found to be nonsense.

The company was dissolved in September 2018. Founder Elizabeth Holmes – once touted as the future of business – will stand trial in 2020 on wire fraud and conspiracy charges. And investors have lost everything.

No profit

Of course, Theranos was built on an entirely false claim. Nobody’s claiming that highly valued companies such as Uber ($82.4bn) and Lyft ($24bn) are bogus.

But neither has ever made a profit, either – and both have recent heavy losses. And neither are performing as well on the stock market as investors hoped. So while nobody’s forecasting their fall any time soon, few are predicting big profits, either.

Mass investment

Platforms such as Crowdcube and Kickstarter have brought start-up investment to the masses. It’s easier than ever to throw some money into a new venture and hope for big returns.

And the publicity surrounding huge valuations and vast profits – for some – can make this kind of investment seem far more attractive to the average investor than dividends from a reliable-but-dull company, which isn’t likely to have profits in the stratosphere any time soon.

After all, who wouldn’t want to be part of the next Facebook – $104bn at its IPO in 2012, now worth $536bn? An investor who put $1000 into Facebook back in 2012 would now be looking at a gain of five times their original investment, according to Investopedia.

Low initial costs

A tech idea doesn’t have to cost a lot to develop, either, making it more attractive for investors. As the Funders Club points out: “Tech start-ups often require small amounts of capital to start, are relatively capital efficient to scale, can grow quickly by leveraging technology, and can develop barriers to entry for competitors that allow for the building of a valuable enterprise.”

So, if you’re convinced you’ve found the next big thing, by all means go for it. But never invest any more than you can afford to lose, and ensure that it’s part of a varied portfolio which includes historically safer havens, such as gold.

Portfolio diversification

As a strategic asset, gold has improved the risk-adjusted returns of portfolios, delivering returns while reducing losses and providing liquidity to meet liabilities in times of market stress.

Gold historically benefits from periods of heightened risk. By providing positive returns and reducing portfolio losses, gold has been especially effective during times of systemic crisis when investors tend to withdraw from stocks. While this isn’t happening currently – yet – Gold has also allowed investors to meet liabilities while less liquid assets in their portfolio were undervalued and possibly mis-priced.

The greater a downturn in stocks and other risk assets, the more negative gold’s correlation to these assets becomes. But gold’s correlation doesn’t only work for investors during periods of turmoil. It’s long-term price trend is actually supported by income growth – research shows that when stocks rally strongly their correlation to gold can increase, driven by the wealth effect and, sometimes, by higher inflation expectations. (Source: World Gold Council)

Finally, when it comes to valuations of unicorns – privately owned companies valued over $1 billion – that old saying still holds: does it sound too good to be true? Then it probably is.

 

Important disclaimer: this document is not an official research report and the views expressed in it are those of the authors. The authors are not registered research analysts and there is no assurance the trends mentioned will continue or that the forecasts discussed will be realised. Gold as a commodity is not a specified investment for the purpose of giving advice under the Financial Services and Markets Act 2000, therefore, it does not give rise to rights to claim compensation under the Financial Services Compensation Scheme.