Shareholders of Wayfair (NYSE:W) got a rude wake-up call on Thursday. The home furnishings e-tailer's third-quarter earnings report showed very strong sales growth at 39%, but the lack of any signs toward profitability -- in fact, a widening of losses -- caused Wall Street to sour on its prospects. Shares of the company were down by as much as 20% after earnings were released.

While there's still a lot to be hopeful for, the most recent quarter raises a few yellow flags that investors need to be aware of.

Two men removing large boxes from a van.

Image credit: Getty Images

Wayfair earnings: The raw numbers

Here's how the company performed on the headline numbers:

Metric

Q3 2017

Q3 2016

Year-Over-Year Growth

Revenue

$1,198 million

$862 million

39%

Non-GAAP earnings per share

($0.65)

($0.54)

Loss widened by 20%

Free cash flow

($18.5 million)

($14.0 million)

Loss widened by 32%

Data source: Wayfair. Percentages rounded to nearest whole number.

Revenue growth has always been strong at Wayfair, so the continued top-line growth is no surprise. But it's the lack of profitability -- or any obvious path leading to it -- that has investors concerned.

There were two main culprits for the widening loss. The first was a massive increase in spending on operations and technology -- which jumped 43% to $113 million. To put that in perspective, this item alone ate up 40% of the company's gross profit. This showing, however, shouldn't be surprising. In following Amazon's footsteps of building out an unbeatable network of fulfillment centers, Wayfair has spent massively on its Wayfair Delivery Network and CastleGate locations.

The second and more worrying culprit was a 40% increase in advertising spend. Wayfair already claims on its website that brand awareness in the U.S. is at 84%. While some of that additional ad cost is no doubt related to expansion efforts in Canada, the U.K, and Germany, management was peppered with questions about why these costs have continued to be so high. Management stated that these costs were worth it -- as the ads were adding long-term customers -- but analysts were unimpressed.

Digging deeper

Here are some more granular metrics worth tracking:

Metric

Q3 2017

Q3 2016

Year-Over-Year Growth

Active customers

10.25 million

7.36 million

39%

Total orders delivered

4.7 million

3.4 million

38%

Orders by repeat customers

2.88 million

1.94 million

48%

Data source: Wayfair. 

Overall, these numbers appear very strong. Yet the key question, as always, remains whether and when the company will reach profitability.

If Wayfair can cut back on advertising spend and still add the requisite numbers of new customers and orders, the investments in the delivery network could provide a meaningful moat that make it the home furnishings e-tailer of the future.

If, on the other hand, those new customers don't show up without more and more advertising spend -- or the company starts to run into liquidity issues -- there could be trouble ahead. On the latter issue, the company now has $328 million in low-interest long-term debt. Management made it clear that the new debt was taken on to allow more flexibility as the company continues to scale. Given the low interest and the net cash (and investments) position of $312 million, this debt shouldn't be a huge problem.

Still, Wayfair's real test would be in finding a way to become cash flow positive without having to issue more debt or turn to the markets for a secondary offering.

Looking ahead

Management predicts that revenue will come in between $1.15 billion and $1.40 billion next quarter. That represents year-over-year growth of 37% to 40%, and may potentially be a low-ball figure, as quarter-to-date sales growth is already up 40% with two months still to go. 

If that level of sales growth can be reached, investors will want to keep a close eye on advertising costs and on the balance sheet. 

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Brian Stoffel owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon and Wayfair. The Motley Fool has a disclosure policy.