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Why investing in unprofitable tech shares can cost you a fortune

Just yesterday, I wrote an article on a number of tech stocks chasing more handouts from shareholders or sophisticated investors. Companies with low and falling cash balances often get sold down heavily by investors who realise they will need to raise capital soon.

Unfortunately, this compounds the problem by forcing the company to raise capital at a discount to its last traded price, which is usually substantially lower than it was before the selling started.

Here’s a quick look at how some of the most recent capital raisers have performed on the stock market:

Source: Google Finance

Source: Google Finance

As readers can see, and with the conspicuous exception of Freelancer Ltd (ASX: FLN), every one of these unprofitable, cash-burning tech stocks has been sold off heavily in recent months. iCar Asia Ltd (ASX: ICQ) is the second best performer, recovering from lows of $0.60 after it raised capital from investors last year.

Newzulu Ltd (ASX: NWZ) and Rent.com.au (ASX: RNT) are down in the dumps because they’re currently raising capital, while 1-Page Ltd (ASX: 1PG) and Ziptel Ltd (ASX: ZIP) are possibly being sold off because the market suspects further capital raisings could be in the works.  iWebGate Ltd (ASX: IWG) was also sold off heavily as a result of its recent capital raisings.

Even tech stock XERO FPO NZX (ASX: XRO), the unprofitable accounting software wunderkind from New Zealand, has been sold off heavily as investors become uncomfortable with its dwindling cash balances and constant cash outflows. Xero shares are down 40% in the past year as a result, although longer-term shareholders might also remember that shares leapt higher last year after a US$100 million investment was made in the company in February.

Foolish takeaway

Without commenting specifically on the diverse prospects of these businesses, buying shares in an unprofitable company with a limited cash balance and ongoing cash outflows is not the ticket to a happy shareholder. There’s nothing to say the business won’t go on to become successful, but shareholders should be prepared to put up with potentially serious falls in the value of their shareholding in the meantime. As such, these shares are suitable only for investors with a high tolerance for risk.

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Motley Fool contributor Sean O'Neill owns shares of iCarAsia Limited, Newzulu Ltd, and Xero. The Motley Fool Australia owns shares of Xero. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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