Unprofitable growth stocks to remain under pressure from higher interest rates By Investing.com

Recent years have seen the performance of unprofitable growth stocks heavily influenced by the trajectory of inflation and interest rates.

This sensitivity is primarily due to their long duration profiles and the necessity to fund operations through other methods.

According to Goldman Sachs strategists, the typical stock anticipated to reach profitability this year or next has declined by 4% year-to-date. Meanwhile, firms 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%.

“Unprofitable growth stock EV/Sales multiples have compressed from 14x in 2021 to 4x today, but this change appears appropriate in relationship to the shift in the interest rate environment,” Goldman strategists said in a recent note.

One of the key reasons why unprofitable growth stocks are particularly vulnerable to rising interest rates are their long-duration cash flows and future-focused financial projections, strategists explained.

These stocks, expected to grow future sales significantly more than the average Russell 3000 company, face greater valuation pressure from increased discount rates. Moreover, the higher cost of capital complicates their ability to raise necessary funds, often requiring them to issue dilutive equity or high-cost debt, or to seek acquisition.

“This dynamic has made valuations for unprofitable growth stocks more sensitive to changes in interest rates relative to their profitable peers,” Goldman’s team noted.

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 “limited potential valuation upside for unprofitable companies without a near-term path to profitability,” they said.