Now that domestic ride-hailing service Lyft has made its market debut amid massive hype, it’s a good time to take a step back and look at the company’s — and its stock’s — so-called “potentialities.”
As users of Lyft, as well as its larger competitor Uber, which is expected to soon follow it onto the public markets, we can attest that the service is awesome. But that doesn’t mean that the business is awesome.
Both apps have been downloaded more than 100 million times, and the two companies have provided billions of rides and generated tens of billions in revenue. Most investors have used a ride-hailing app and understand the basic logic of the business model: We signal our need using the app, the algorithm dispatches a driver-owned vehicle to take us where we need to go, and payment is automatically charged to our credit cards.
A key reason why Lyft and Uber are so attractive is that their services are reasonably priced. However, the pricing has been subsidized by private equity investors. Neither firm has been able to generate a profit. Potential stock owners should make investment decisions based on bottom-line profitability (or the prospect thereof), not top-line revenue.
Warren Buffett says, “Never invest in a business you cannot understand.” We agree. But knowing what you do and don’t understand can be elusive.
A little knowledge can lead investors astray. Incomplete understandings can be tied together by stories to generate meaning, particularly when such understandings align with our observations.
So, maybe you’re thinking, “Lyft is a useful service that is generating billions in revenues and therefore will become a profitable business.” Will it, though? We still know very little about whether the usefulness — and the top-line revenue — will lead to bottom-line profits.
Though the Lyft prospectus shows no evidence of profit, its pages describe how its large customer base will be leveraged for future profit. (Oh dear.) But the prospectus also includes page after page of boilerplate language warning investors about what could go wrong. And most investors will gloss over the dry, disconnected verbiage.
Our minds tend to ignore disconnected risks and instead focus on facts that can be put into our already constructed and much-preferred narrative. We are much more likely to weave our experience as customers who have received successful Lyft service into a story about the inevitable success of Lyft stock than we are to consider the risk factors that imply a world without Lyft — or Uber.
Our Lyft and Uber stories aren’t a new phenomenon. For decades, technological innovations have had expert investors weaving elaborate stories about how something that was so obviously useful would lead to great profit. Hordes of people put their money where the plots were, and many of these plots didn’t have happy endings.
Were these experts deliberately misleading would-be novice investors? Not necessarily. Something new — like radio in the 1920s or e-commerce in the 1990s — renders existing expertise useless. There can be no so-called experts in something that is new to the world.
Generalized narratives of success, coupled with access to specific, available investment choices — so-called pure-play investments, like buying a share of Lyft or Uber — are likely to fuel investment narratives that can generate bubbles.
So, should you invest in Uber or Lyft? One historical lesson is clear: Invest only if you have an understanding of the company’s cost structure or can see strong evidence of prospective profitability. Otherwise, you are more likely inflating a bubble and, most certainly, you are bailing Lyft's or Uber's prior investors out of their money-losing ventures.
David A. Kirsch (email@example.com) and Brent Goldfarb (firstname.lastname@example.org) are the authors of “Bubbles and Crashes: The Boom and Bust of Technological Innovation,” released in February by Stanford University Press. They are both associate professors of management and entrepreneurship at the University of Maryland's Robert H. Smith School of Business.