U.S. 10-year Treasury yield as a “risk-free rate”, its movement on the financial markets has a very important indicator role. Generally speaking, when the debt rate rises, high valuation, no profitability of technology stocks by the impact of the largest. Therefore, the recent bond interest rates and technology stocks dominated by the NASDAQ is an inverse trend.
To understand the impact of rising debt rates on the stock market, we must first know how the market “values” a stock. In the U.S. stock market, institutional investors, as the “big players”, are the strongest force to dictate the direction of the market, they will decide whether to buy or hold a stock based on different indicators, and use various “valuation models” to project the reasonable value of the stock, so as to make investment The decision is made by using various “valuation models” to project the reasonable value of a stock.
Generally speaking, stock valuation methods can be divided into “relative valuation” and “absolute valuation”. In the relative valuation method, the most common is to calculate the “price-to-earnings ratio (PE, i.e., earnings per share divided by current price)”, “price-to-book ratio (PB, net asset value per share divided by current price)” and other indicators, through the business with similar enterprises, or historical trends for comparison, to estimate the reasonable value of an enterprise. To estimate the reasonable value of a company by comparing it with similar businesses or historical trends.
However, for most technology companies in the rapid growth stage of business, the relative valuation method basically can not reflect its reasonable value, because most of these companies have not yet recorded profits, can not calculate PE (because earnings are negative, can not be divided), but also because of its light asset model, also led to the market-to-book ratio (PB) valuation is also not very useful, so most major banks will use ” Cash flow discount model (DCF model)” for valuation.
One of the core logic of the DCF model is that money has a “Time value”, that is, the money today is worth more than the same amount tomorrow. For example, let’s say a company has $1 million in cash to invest in its business and gets $1.1 million (10% return) with interest in a year, then next year’s $1.1 million is only worth $1 million today. In this way, cash in the more distant future is worth even less.
Thus, the DCF model estimates the future cash flows that a company can generate and discounts them to their present value using a “discount rate” to arrive at a reasonable current value for the stock.
The discount rate will also be affected by the risk-free rate (generally equivalent to the U.S. 10-year debt rate). The rationale behind this is that as long as you buy “zero-risk” U.S. Treasuries now, you will be able to generate a stable return, so why risk for future returns? Therefore, when the debt interest rate is higher, the discount rate will also be higher.
In other words, when the U.S. debt interest rate is higher, today’s money will be more valuable, and some sacrifice the current profits for more future income of technology stocks, growth stocks, its valuation is the most serious blow.