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Cash-burn companies not always bad investments, professor says

Companies that burn a lot of cash are not necessarily bad investments and could be a missed opportunity if ignored, NYU Stern School of Business finance professor Aswath Damodaran said Tuesday.

That's because with young companies, it's natural to have negative cash flow on a year-by-year basis, he said.

"If you avoid companies just because of cash burn, you're taking big segments of the market out of your portfolio," Damodaran said in an interview with CNBC's "Closing Bell."

burning money
Steve Bronstein | Getty Images

He believes it's important to look at the underlying business when deciding whether to invest.

"You've got to make a judgment on what that business will look like if the company makes it. You've got to be an optimist. You cannot be a pessimist and look at these companies."

Management also matters a great deal, he pointed out.

So when should investors make the call on whether the business will be profitable and grow? Damodaran said it depends on how big the dream is.

And that is the problem with one well-known cash-burn company, Tesla, he said.

"[CEO] Elon Musk every year expands his dream so it's almost like he's moving the goal post which is a little difficult for investors because you have to readjust."

While Tesla's automobile business looks like it is leading into positive cash flow, its solar business is a cash-burn business without an end in sight, Damodaran said.

Earlier this month, Tesla reached a deal to acquire SolarCity for $2.6 billion, a move that Musk has said would allow its customers to harness the power of the sun in an "end-to-end clean energy product" as soon as next year.

"It's almost like you've got what I call the benign version of cash burn and the malignant version in the same company and I'm not sure which one is going to win out," Damodaran said.

— CNBC's Linda Sittenfeld and Christine Wang contributed to this report.