In recent years, the performance of unprofitable growth stocks has been heavily influenced by inflation and interest rates. This sensitivity is mainly due to their long duration profiles and the need to fund operations through other methods.
Goldman Sachs strategists have noted that the typical stock expected to reach profitability this year or next has declined by 4% year-to-date. Meanwhile, companies projected to become profitable in 2026 have seen a 15% decrease, and stocks expected to turn profitable after 2026 have experienced a significant drop of 28%.
The EV/Sales multiples of unprofitable growth stocks have compressed from 14x in 2021 to 4x today. This change is seen as appropriate in relation to the shift in the interest rate environment.
One of the main reasons why unprofitable growth stocks are particularly vulnerable to rising interest rates is their long-duration cash flows and future-focused financial projections. These stocks, expected to grow future sales significantly more than the average Russell 3000 company, face greater valuation pressure from increased discount rates. The higher cost of capital also complicates their ability to raise necessary funds, often requiring them to issue dilutive equity or high-cost debt, or to seek acquisition.
The valuation contraction of these stocks aligns with shifts in the interest rate environment, which has seen a sharp rise following historically low rates and economic optimism in late 2020.
Looking ahead, with forecasts indicating the 10-year US Treasury yield will stay above 4% through 2025, there appears to be limited potential valuation upside for unprofitable companies without a near-term path to profitability.