Why Growth Stocks are so Enticing in Low Rate Environment

Currently, rates are basically the lowest they have been in history with the 10 Year Treasury at 0.60% and 30 Year Treasury at 1.25%.

Historical Trend CNBC -

Under such an atmosphere, growth stocks with their lofty valuations and endless spending actually become very enticing. Assuming a growth company can successfully spend a lot of money now (i.e. R&D, Marketing, etc.) to achieve a market advantage that propels them to positive earnings in say 7 years; and further earnings growth beyond that; the math tends to suggest they may be worth an investment......particularly when interest rates are at rock bottom levels.

Their value comes from the concept of opportunity cost. Right now, with low interest rates being offered on fixed income investment options, the opportunity cost of missing out on the income streams offered by fixed income in favor of investing in opportunities that are losing money now, are not that great, relative to historical benchmarks.

For example,

  • Assuming a 1% interest rate, a cash flow of $1,000,000 in 20 years would be worth $819,544.47 today.

  • 3% interest rate; $1,000,000 in 20 years would be worth $553,675.75 today.

  • 5% interest rate; $1,000,000 in 20 years would be worth $376,889.48 today.

  • 10% interest rate; $1,000,000 in 20 years would be worth $148,643.63 today.

As a result, an anticipated $1,000,000 cash flow stream 20 years from now in a 1% rate environment is worth more than 200% more today than the same cash flow stream in a 5% rate environment.

Therefore, although the concept of investing in a free spending company today may seem misguided intuitively, math suggests one should buckle up for volatility and take growth over value; particularly at a young age. That said, a company that is ultra-unprofitable now and claims to be a "growth" company should have the consistent sales growth (i.e. greater than 20% YoY) to prove their characterization is true...

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