COTW: Not All Tech Companies Are Built Equal

October 17, 2022COTW: Not All Tech Companies Are Built Equal

  • Like most bear market environments, 2022 has seen growth stocks materially underperform their value counterparts. Of the growth stocks, tech has been among the hardest hit, with the S&P 500 tech sector down 33% year to date — trailing the broader index by over 8.0%. One of the key contributors to the underperformance of growth, and tech, has been the sharp rise in interest rates over the year.
  • One way of calculating the fair value of a company is by discounting all future cash flows to their present value. Therefore, when interest rates rise, future cash flows become less valuable as they are discounted at a higher rate due to the increased opportunity cost.
  • The timing of cash flows can also exacerbate the effect of higher discount rates as cash flows further out are discounted for a longer period relative to near term cash flows. For example, non-profitable companies which are only expected to start generating cash flows several years down the line are more impacted by discount rates than profitable companies with stable cash flows. This can be evidenced in the year-to-date performance of non-profitable tech companies, which (as proxied by the Goldman Sachs Non-Profitable Tech Index) has lost -61.9% year to date — almost 19.1% more than S&P 500 tech stocks. The longer the high interest rate environment persists, the more headwinds non-profitable businesses will face.


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