The drop in valuations of unprofitable growth stocks looks appropriate given the interest rate environment, according to Goldman Sachs.
“One reason unprofitable stocks are sensitive to interest rates is their long duration cash flows,” strategist David Kostin wrote in a note. “Because their cash flows are expected to be generated in the distant future, unprofitable stocks face larger headwinds from an increase in the discount rate than the typical stock.”
“Another reason that the higher cost of capital environment creates challenges for unprofitable stocks is that many firms need to raise capital to continue operations,” Kostin said. “While profitable growth stocks may be able to fund operations through cash flows, some unprofitable growth stocks may need to raise capital to remain solvent.”
“These firms will be forced to either find an acquirer, issue dilutive equity, or issue debt at elevated current rates.”
“The challenges of a high interest environment for unprofitable stocks also helps explain some of the recent weakness of small-caps,” Kostin added. “Consensus currently expects that 31% of companies in the Russell 2000 (NYSEARCA:IWM) will be unprofitable over the next 12 months vs. 0% for the S&P 500 (NYSEARCA:SPY) (IVV) (VOO).”
“Our economists’ forecast that the 10-year US Treasury yield (US10Y) (TBT) (TLT) will remain above 4% through 2025 suggests limited potential valuation upside for unprofitable companies without a near-term path to profitability,” he said. “Furthermore, our economists expect the fed funds rate to settle at 3.25-3.5% in 2026 and the nominal 10-year US Treasury yield to end 2025 at 4.1%.”
“We highlight a screen of 21 growth stocks that were unprofitable in 2023 and that consensus expects to become profitable in 2024 or 2025 and that trade at FY2 EV/Sales less than 5x.”
The stock universe is the Russell 3000 (NYSEARCA:IWV):
- Cipher Mining (CIFR), estimated 2025 sales growth 84%, estimated 2024 consensus EPS $0.3
- Indie Semiconductor (INDI), 48%, 0.2
- TeraWulf (WULF), 48%, 0.3
- Aspen Aerogels (ASPN), 44%, 0.7
- Fluence Energy (FLNC), 30%, 0.9
- ACV Auctions (ACVA), 26%, 0.4
- Hims & Hers Health (HIMS), 25%, 0.4
- Westrock Coffee Company (WEST), 25%, 0.2
- Bloom Energy (BE), 24%, 0.4
- MediaAlpha (MAX), 24%, 0.0
- Inspire Medical Systems (INSP), 21%, 0.8
- Xometry (XMTR), 20%, 0.4
- DraftKings (DKNG), 20%, 0.8
- EverQuote (EVER), 19%, 0.1
- Spirit AeroSystems (SPR), 17%, 1.7
- DoorDash (DASH), 17%, 1.4
- Zeta Global (ZETA), 15%, 0.3
- Weave Communications (WEAV), 15%, 0.1
- PAR Technology (PAR), 14%, 0.1
- Fastly (FSLY), 13%, 0.1
- Rush Street Interactive (RSI), 12%, 0.3