Two schoolmates and seasoned investors met after decades in a cafe. As they sipped their mug, their ears perked up to a song “It’s ourselves under pressure.” Under pressure.’

Veena: My wallet has been under pressure recently. I was heavily invested in the Nasdaq 100 funds, startup tech, and growth stocks and believed they would continue to perform well.

RAM: Some of them could do well in the long term, but in the short to medium term, they will continue to remain under pressure if recent concerns about inflation in the United States persist.

Veena: Why should inflation or interest rates impact tech stocks?

RAM: Stock markets look to future earnings and discount them to the net present value (NPV). When Treasury yields rise due to concerns about inflation, your discount rate increases and your NPV of profits decreases.

Veena: Yes, but I still don’t understand why growth stocks should fall more than other stocks?

RAM: This is because the earnings of growth stocks are more loaded in the background. For example, if you take a five-year period, most of the growth stock benefits can only come from the 4th and 5th year.

Since the income is five years from now, you need to discount it five times. When interest rates are low, this therefore works in favor of growth stocks.

Veena: So you mean when interest rates go up the discount rate goes up and it impacts the NPV of profits in later years?

RAM: Yes. Check this out on Excel. Suppose a discount rate of 6% and there are 2 companies A and B (growth) with the same total income of ₹ 100 in 5 years, but A gives a profit of ₹ 20 for each of the 5 years, and B gives earning ₹ 100 only in 5th year. A’s profit NPV is ₹ 84.25 and B’s is ₹ 74.73. Raise the rate to 8%, A’s NPV is ₹ 79.85 and B’s is ₹ 68.06.

Veena: The NPV of A decreases by 5.2%, while that of B decreases by 8.9% due to the 2% increase in interest rates?

RAM: Bingo! As a result, growth stocks are under pressure.