Why Investors Should Study Failure

Investment research naturally gravitates towards winners. Investors study the companies that transformed industries, compounded earnings and delivered exceptional shareholder returns. Their strategies become case studies, their founders become visionaries and their business models are presented as templates for others to follow.

Yet success can be a misleading teacher.

A successful company may have benefited from favourable market conditions, cheap financing, fortunate timing or a temporary lack of competition. It can therefore be difficult to determine whether its performance came from genuine strategic excellence or from circumstances that may never be repeated.

Failure is often less ambiguous. When a company collapses, abandons a market or destroys significant shareholder value, the weaknesses in its strategy become much easier to see. Failed businesses show investors what happens when optimistic assumptions encounter economic reality.

Studying failure is not about becoming permanently pessimistic. It is about understanding how businesses break—and recognising the warning signs before the market does.

Growth Can Hide a Weak Business Model

Rapid expansion is frequently interpreted as evidence that a company has discovered a powerful business model. More locations, customers, employees and revenue can create the appearance of increasing strength.

However, growth does not always improve a business. In some companies, each new sale, store or market adds more risk than value.

WeWork became one of the clearest examples. Its model involved taking long-term leases on office buildings, redesigning the space and renting it to customers under much shorter agreements. When occupancy was strong and capital was readily available, the company appeared to be building a global workplace platform.

But its expansion also created substantial fixed commitments. In 2018, WeWork recorded a net loss of approximately $1.9 billion. Its filing acknowledged that losses were expected to continue growing in absolute terms as the company expanded. The central weakness was that long-term property obligations were being supported by customers who could often leave within a much shorter period.

Expansion did not eliminate this mismatch. It multiplied it.

This distinction is critical for investors. A genuinely scalable business should become more efficient as it grows. Its customer-acquisition costs may fall, purchasing power may increase and fixed expenses should be spread across a larger revenue base.

A weak model behaves differently. Revenue increases, but losses, capital requirements and contractual obligations rise just as quickly. Growth may postpone scrutiny because the headline numbers remain impressive, but the underlying economics do not improve.

The relevant question is therefore not simply whether a company is growing. It is whether each additional unit of growth makes the company stronger.

Temporary Demand Can Be Mistaken for Permanent Change

Companies frequently fail because they extrapolate unusually favourable conditions too far into the future.

Peloton experienced extraordinary demand during the pandemic, when gyms were closed and consumers were spending more time at home. The company responded by investing in inventory, manufacturing capacity, logistics and physical infrastructure.

The problem was not that demand had never existed. The problem was that its durability was overestimated.

As restrictions ended and consumers returned to gyms and other activities, Peloton was left with a cost base and inventory position designed for a much larger market. The company reported that declining demand had contributed to excess inventory, discounting and write-downs. Its connected-fitness gross margin fell from 29% in its 2021 financial year to negative 11.3% in 2022, while its net loss widened to approximately $2.8 billion.

Peloton subsequently launched a restructuring programme involving headcount reductions, facility closures, the abandonment of planned manufacturing capacity and a move away from owned manufacturing. Charges associated with the programme reached more than $600 million in its 2022 financial year.

The broader lesson extends beyond pandemic beneficiaries. Investors must distinguish between structural demand and pulled-forward demand.

Structural demand reflects a durable change in customer behaviour. Pulled-forward demand occurs when customers purchase today what they would otherwise have bought over several future years. Both can produce exceptional short-term growth, but their long-term implications are very different.

When evaluating a fast-growing company, investors should ask what conditions produced that growth. Was it driven by lasting competitive advantages, or by temporary factors such as lockdowns, shortages, stimulus, low interest rates or unusually high commodity prices?

A company that builds permanent capacity around temporary demand can quickly turn a period of success into a balance-sheet problem.

Debt Removes the Margin for Error

Most strategic mistakes can be corrected if a company has sufficient time and liquidity. Debt reduces both.

Borrowing can enhance shareholder returns when cash flows are stable and capital is deployed productively. It becomes dangerous when companies use leverage to fund acquisitions, disguise weak cash generation or maintain distributions that the underlying business cannot support.

Carillion illustrates how these risks can accumulate.

A UK parliamentary investigation described the company’s strategy as being driven by acquisitions, rising debt and expansion into new markets. Despite growing financial pressure, Carillion continued increasing its dividend and presented an overly positive picture of its position.

In July 2017, the company announced an £845 million reduction in the value of its contracts. Just months earlier, it had published apparently strong accounts and paid a record £79 million dividend. Carillion entered liquidation in January 2018 with liabilities approaching £7 billion and only £29 million in cash.

Carillion’s collapse shows that leverage should not be assessed only through a debt-to-earnings ratio. Investors must also examine the quality of the earnings used in that calculation.

Contractors, property developers and other project-based businesses may recognise accounting profits long before the related cash arrives. If projects encounter delays, cost overruns or disputes, expected profits can disappear while the debt remains.

Debt therefore creates an asymmetry. It allows shareholders to benefit from successful expansion, but lenders must still be paid when the strategy fails.

The most important question is not whether a company can service its debt under management’s forecast. It is whether it can continue servicing that debt if revenue falls, margins compress or major projects underperform.

A balance sheet should be judged against an adverse scenario, not merely the base case.

A Successful Model May Not Transfer to a New Market

Companies often assume that success in one country, customer segment or product category can be reproduced elsewhere. Sometimes it can. But brand recognition does not guarantee operational fit.

Target’s Canadian expansion provides a useful example.

The retailer entered Canada with a strong US brand and substantial consumer awareness. However, the expansion was ultimately abandoned, and Target’s Canadian subsidiaries filed for creditor protection in January 2015. The company recorded approximately $5.1 billion in pre-tax impairment and other charges connected to the exit.

The failure demonstrates the difference between possessing a recognised brand and delivering the proposition customers associate with that brand.

When companies enter new markets, they encounter different supply chains, customer expectations, property costs, regulations, competitive structures and purchasing habits. A strategy that works in one environment may lose its advantage when these conditions change.

Investors should therefore treat international expansion as a new business case rather than an automatic extension of the existing one.

The key question is not whether customers recognise the company. It is whether the company can reproduce its economics, service quality and competitive advantage under local conditions.

Management Behaviour Often Matters More Than Management Language

Corporate failures rarely arrive without warning. The signs may be visible in financial statements, but they are also frequently visible in management behaviour.

Investors should become cautious when executives:

• repeatedly introduce adjusted performance measures that exclude recurring costs;
• blame external conditions for problems that competitors are managing successfully;
• continue paying large dividends while cash flow and leverage deteriorate;
• pursue acquisitions while the core business remains unstable;
• change strategic targets without acknowledging earlier mistakes; or
• describe every setback as temporary while repeatedly requesting more capital.

None of these behaviours proves that a company will fail. However, together they may indicate that management is prioritising the appearance of progress over the health of the business.

Strong management teams do not avoid mistakes entirely. They identify problems early, communicate them clearly and take corrective action before their options disappear.

Weak management teams often do the opposite. They defend previous decisions, delay restructuring and increase risk in an attempt to recover lost momentum.

Failure Reveals the Importance of Financial Flexibility

One of the most consistent lessons across corporate failures is the value of optionality.

Companies with cash, manageable debt and flexible cost structures can survive periods of poor execution. They can close underperforming divisions, renegotiate contracts, invest through downturns and wait for demand to recover.

Companies with high fixed costs, excessive borrowing and substantial contractual obligations have fewer choices. Even a temporary fall in revenue can become an existential problem.

This is why liquidity should not be treated as idle capital. Cash may reduce headline returns during good periods, but it provides strategic freedom when conditions deteriorate.

For investors, the relevant measure is not simply how efficiently a company operates when everything goes according to plan. It is how much room it has when the plan proves wrong.

A Practical Failure Checklist

Studying failed companies can be converted into a repeatable investment process. Before investing, it is useful to ask:

Is growth improving the economics? Revenue expansion should eventually strengthen margins, cash generation or competitive positioning. If growth continuously requires more capital without producing better returns, scale may be magnifying the weakness.

How much of demand is temporary? Investors should normalise unusually strong periods and consider whether customers are bringing future purchases forward.

What happens in a downturn? Stress-test earnings, cash flow and debt service under weaker revenue and lower margins. A company that only survives under optimistic assumptions carries greater risk than its valuation may suggest.

Can the business model travel? New countries, products and customer groups should be assessed independently. Previous success provides credibility, but not certainty.

Are profits converting into cash? Persistent differences between reported earnings and operating cash flow deserve investigation, particularly in project-based and acquisition-heavy businesses.

Is management correcting mistakes or defending them? The speed and honesty with which executives respond to failure often determine whether a setback remains manageable.

Failure Is Part of Investment Education

Investors are often encouraged to search for the next exceptional company. That remains important, but avoiding permanent losses can be just as valuable as identifying spectacular winners.

Corporate failures teach investors to look beyond narratives. They demonstrate that revenue is not the same as value creation, that expansion is not always progress and that debt can transform a strategic error into a crisis.

They also reveal a central truth about investing: businesses rarely fail because of a single bad quarter. Failure usually develops through a sequence of decisions—expanding before proving the model, borrowing before stabilising cash flow, ignoring local market differences or assuming temporary conditions will continue indefinitely.

The final collapse may appear sudden. The underlying weaknesses were often present for years.

Investors who study failure learn to recognise those weaknesses earlier. They become less impressed by growth without cash flow, less tolerant of fragile balance sheets and more sceptical of strategies that leave no room for error.

Success shows what is possible.

Failure shows what must be avoided.