Technology unicorns are in the spotlight, with Uber’s high-profile IPO expected this week. As scrutiny of their business models intensifies, we think investors should also ask tough questions about publicly traded companies with high sales growth but scant cash flows.

Uber’s quest to raise $10 billion is making big headlines. It’s one of a group of privately held firms worth at least $1 billion, known as the unicorns, including Airbnb and WeWork. Globally, there are more than 300 unicorns worth about $1.1 trillion, according to CB Insights. These companies have garnered millions of users and customers around the world, and many have generated strong sales. But collectively, they’ve racked up billions of dollars in losses, and few have posted any profits at all.

Perhaps coincidentally, investors in US stocks have been enamored by sales growth recently. In the first quarter of 2019, shares of US companies with high sales growth delivered relative returns of 3.4% versus the S&P 500, while those with high profitability fell by 2.9% (Display, left). This contrasts with the long-term tendency of high-sales-growth companies to underperform those with high profitability, as measured by returns on assets. What’s more, our research shows that companies with the strongest sales growth are also the least profitable (Display, right).

Risk Appetite Reduces Sensitivity to Profitability

So what’s been going on? In some ways, these performance patterns aren’t unusual. During the first quarter, markets shifted back to risk-on mode after the late-2018 downturn. When risk appetite improves, investors feel more comfortable buying stocks with little or no profitability. Like the unicorns, strong sales growth in a publicly traded company looks like an appealing attribute that may signal future profitability potential, especially in a world of slowing macroeconomic growth.