It is not unusual for fast-growing companies to operate at a loss. Several factors could cause loss: spending to keep up with or induce demand, for example, or introductory pricing on products and services to accelerate customer adoption.
Regardless, companies operating at a loss for the sake of growth add risk for investors. It's difficult to foresee whether a business can earn healthy profits when it reaches maturity, or even if the company will survive long enough to reach maturity.
However, the rewards can be magnificent for investors who can pick winning stocks early in their growth phase. Here are two unprofitable growth stocks that have the makings of long-term winners.
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1. DraftKings
DraftKings (DKNG -6.08%) offers a unique set of online gaming services. Folks can go to DraftKings to wager on daily fantasy sports, bet on their favorite team in the mobile sportsbook, or gamble on casino-style games like blackjack.
Because it's a gaming company, it relies on a state government to grant it a license to operate within its jurisdiction. DraftKings has a license to operate in 15 states with a mobile sportsbook and only five with iGaming.
Legalizing online gaming is a relatively new phenomenon, and DraftKings is growing hand in hand with state approvals. Between 2017 and 2020, DraftKings increased revenue from $192 million to $615 million. And it has accelerated its revenue growth in each of those years, ending 2020 at a 90% increase -- hypergrowth, to be sure.
Earning profits on the bottom line has been another story. The company is generating massive losses as it invests in expansion. With each new state granting DraftKings a license, the company spends aggressively on customer acquisition. Furthermore, with its sportsbook operating in only 15 states and iGaming in only five, spending on growth is not stopping anytime soon. In the nine months ended Sept. 30, DraftKings generated an operating loss of $1.2 billion, up from $574 million during the same period the year prior.
If and when DraftKings reaches maturity, the return on investment could be worthwhile. According to management, the North American total addressable market for iGaming and mobile sportsbooks is worth an estimated $67 billion annually. From this, DraftKings projects it can earn annual revenue of $6.2 billion at the midpoint. That's more than 10 times its $615 million in revenue in 2020.
2. Peloton
Peloton Interactive (PTON -0.32%) has grown sales of its interactive exercise equipment rapidly over the last several years. From 2017 to 2021, revenue increased from $219 million to $4 billion. Many companies have sold at-home exercise equipment, but Peloton has pioneered connecting equipment with interactive classes.
Consumers show a preference for exercising at home because of the added convenience of not having to drive to the gym, look for parking, and then find a suitable exercise machine or a class that fits their schedule. Before my gym in Los Angeles closed because of COVID-19, driving the four miles from my house and finding parking would regularly take longer than 30 minutes.
As with DraftKings, profitability has been elusive for Peloton. The company has generated operating losses in the last five years and has started off fiscal 2022 on a similar note. In its first quarter of fiscal 2022, ended Sept. 30, it lost $376 million on the bottom line. The losses result from pricing its products low enough to generate robust customer demand. That plan appears to be working as revenue has grown by nearly 20 times from 2017 to 2021. However, it's not enough to generate consistent profits.
The long-run potential lies with its subscription business, which generated a 66.7% gross profit margin in its most recent quarter. Once Peloton gets enough of its machines inside people's homes and primarily derives revenue from recurring subscription revenue at that 66.7% margin, the bottom line could consistently show profits.
That's a big "if," but it could be worthwhile for investors who take the risk and buy Peloton stock in this early growth phase.
