Why are unprofitable stocks surging in the AI era?

It seems like many things run on “vibes” these days: vibe coding, vibe management, vibe checks, and increasingly in parts of the market, a vibe economy. With roughly 40% of Russell 2000 Index companies generating negative earnings over the past twelve months,¹ many would view that as a sign of distress, yet over the trailing twelve months through the end of June, the Index is up approximately 40% and up 22% in the first half of 2026.² The returns for only unprofitable companies in the small-cap index are a staggering 154% over the trailing twelve months.³ This isn’t entirely a small-cap phenomenon either. Trailing twelve-month performance for the equally weighted Russell 1000 Index shows unprofitable stocks were up 17%, while profitable company stocks gained 12%. Companies with no earnings in the Russell 1000 Index are a far lower share compared to the small-cap space, approximately 7%, but the performance trend remains similar.⁴

Why are unprofitable stocks surging?

What’s driving these unprofitable companies to such great heights? Several factors. The one most front and center at the moment is artificial intelligence (AI)-driven disruption, which has essentially warped the entire market given the amount of capital expenditure and resources dedicated to creating and training the latest frontier AI models. Enthusiasm over the AI buildout is currently strong enough that companies can burn through cash but continue to raise debt and equity capital, with investors believing the ends justify the means. But AI-related businesses are commonly capital-intensive due to the need for significant computing power, data center infrastructure, and talent retention, which means we’re seeing a greater share of companies come to public markets to drive their AI business models forward.

The growing share of negative-earning companies isn’t purely driven by the AI narrative; it’s also structural. Global venture funding grew from $50 billion to $600 billion annually between 2012 and 2021,⁵ providing a significant alternative to public capital. Profitable companies have the greatest flexibility in this environment. They can continue operating on their own, take private equity capital and sit in a continuation fund, or get acquired. On the other hand, unprofitable companies focusing on growth over margin discipline often start with venture and private equity capital that eventually runs out, then require public markets to fuel their continued growth. This framework biases IPOs toward companies with higher capital needs, which are typically unprofitable, and has allowed the share of no- or negative-earning companies to grow from around 20% of the Russell 2000 Index in the 1990s to the 40% we see today.

While it’s no surprise that smaller, less proven business models, particularly capital-intensive ones, are riskier than larger, proven businesses, a growing concentration could be a concern. Much of the explosive growth seen in the small-cap space has been clustered among companies involved in AI infrastructure, biotech, and the latest software. With a lower share of unprofitable companies, the risk diminishes as you get into mid- and large-cap ranges. However, there could be signs that this is changing, as several large private AI-related companies have pursued or are expected to pursue IPOs despite negative earnings. That’s not to say these companies won’t achieve profitability. There are several instances of successful companies (Amazon, Uber, Tesla, and Palantir) that IPO’d while they were unprofitable. But it wasn’t a given that these companies would achieve profitability, and there are many other examples of recent IPOs (CoreWeave, Snowflake, Rivian, and WeWork) from companies that remain unprofitable or aren’t around anymore. If this small-cap trend works its way up-market, investors need to be mindful of the risks it presents.

How investors can manage risk amid market euphoria

So what’s an investor to do? For one, maintain diversification throughout a portfolio. Diversification can provide exposure to both the unprofitable and profitable segments of the market, while maintaining an allocation to less correlated or uncorrelated parts of the market that can help smooth out periods of heightened volatility.

Second, consider using active management in areas of the market that are more volatile or have greater dispersion in company quality. Most active managers tend to screen out companies with no or negative earnings, choosing instead to focus on companies with positive and sustainable free cash flows and proven business models.

Finally, explore factor-weighted strategies that can overweight specific factors, such as quality or value, to help reduce exposure to frothier parts of the market.

To long-term investors, ebbs and flows or market euphoria aren’t new. The recent performance of unprofitable public companies follows the common market phenomenon of investor enthusiasm driving one segment of the market higher, but past environments suggest market leadership can quickly change. It might be hard to stomach part of an allocation lagging or holding back the performance of an overall portfolio, but timing the market is rarely a viable strategy. Market vibes may come and go, but diversification, discipline, and a focus on fundamentals remain the foundation of long-term investing.

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