If you're bearish on Airbnb (ABNB 0.34%) stock, you probably don't like its lack of profits -- the company has never been profitable, and it had a staggering $4.6 billion net loss in 2020. Furthermore, shares trade at a pricey valuation, with a price-to-sales (P/S) ratio of about 32.
The Airbnb bulls, of course, have counterarguments for the bears. First, they'll point out that many top stocks aren't profitable because they're focusing on growth. Moreover, Airbnb stock perhaps looks more pricey than it actually is. The COVID-19 pandemic temporarily suppressed travel, negatively affecting Airbnb's revenue for 2020 and consequently elevating its P/S ratio. But now with coronavirus vaccinations being distributed, the economy is poised for a rebound to Airbnb's benefit.
The bears say it's an overvalued cash-burning machine, while the bulls say the high price and lack of profits are justified by its growth opportunities. However, both arguments are probably overly simplistic. For the record, I do believe this is a stock to buy and hold. But there's a nuanced explanation you'll want to consider.
Follow the money
Growth investors are understandably comfortable with unprofitable businesses. After all, a great business idea might just need scale to become profitable. In those cases, it can pay to invest patiently in unprofitable companies, anticipating the future cash flows.
However, you shouldn't invest indiscriminately in unprofitable companies in the name of growth. Some so-called growth stocks won't ever create shareholder value because of how they're built. For this reason, we should ask why Airbnb is unprofitable. To answer this, we dive into the statements of cash flows -- where's the money going?
Most of Airbnb's net loss comes from a non-cash expense: Stock-based compensation. For 2020, the company had over $3 billion in stock-based compensation, but this was abnormally high because of its initial public offering (IPO). IPOs cause a one-time spike in compensation because it's recognized all at once rather than gradually.
Stock-based compensation isn't an operating expense, so we can set it aside for our purposes here. Nevertheless, Airbnb had negative cash from operations in 2020 even after adjusting for this non-cash expense. Why?
From 2015 through the end of 2019, Airbnb's revenue increased roughly five-fold. During that time, most operating expenses increased by about the same rate, except one: Product and development (otherwise known as research and development or R&D). Its R&D expenses increased almost 10-fold. And then in 2020, this one line item nearly tripled year over year to almost $2.8 billion.
A potentially rewarding risk
Airbnb is quite literally investing its money back into the business, and I say that's money well spent. The company estimates its addressable market at $3.4 trillion, and I believe Airbnb already has a competitive advantage. Consider that in the first nine months of 2020, only 9% of its users booked because of an ad -- the rest came in by themselves, proving this is the top-of-mind player in the space.
Consumers know all about Airbnb and used it to book over 193 million nights and experiences on the platform during the past year. And yet in 2019 (prior to the COVID-19 pandemic), the company only had 54 million active bookers. That's really small for a global company whose product (travel experiences) has almost universal appeal -- the still extreme growth potential was enough to make me reconsider buying this stock.
Short-term rental hosts are a different story for Airbnb. With just around four million active hosts, the company's putting an outsized portion of that R&D and marketing spend toward recruiting and onboarding more.
Keep in mind that Airbnb is in control when it comes to R&D spending. If profits were required now, it could have spent just 23% less on this one line item in 2020 and been operating-cash-flow positive. But that's not the goal right now. The short-term rental by owner market is still emerging, and companies are jockeying for market share, Airbnb included.
Herein lies the risk. Airbnb is spending on growth, which is smart. But it needs to show a healthy return on this investment. If the company fails to grow its network of hosts meaningfully in 2021 and beyond, it could lose its top-of-mind brand status among consumers. This would require it to start spending more heavily on user acquisition in addition to its current spending on the host experience, complicating its ability to create shareholder value.
How to buy Airbnb
In coming quarters, pay attention to growth with Airbnb's hosts. Lackluster progress there would be a reason to question the company's current capital allocation strategy and would be a valid concern for a long-term Airbnb investment.
That said, Airbnb's top-dog status and massive opportunity make this a stock to buy in my opinion. However, IPOs are often volatile in the first year. For that reason, this is a good stock with which to use the advantage of dollar-cost averaging, building a position slowly over time by making small investments at regular intervals.