In a turn of events that defies conventional wisdom, Big Tech stocks have been on the rise even as interest rates have climbed. While this may seem counterintuitive, the smart debt management strategies employed by these companies have played a significant role in their success.
In recent months, the 10-year Treasury yield has jumped from just under 3.9% to nearly 4.3%. With the market anticipating that the Federal Reserve will continue to keep rates high in its battle against inflation, the future cash flows of companies are becoming less valuable. This is particularly impactful for Big Tech, as these companies are valued based on the assumption that a substantial portion of their profits will be generated many years down the line. As a result, their price-to-earnings (P/E) ratio has been negatively affected. Traditionally, an increase in the 10-year yield contributes to a drop in Big Tech’s P/E ratio.
However, the situation has deviated from the norm as of late. The Nasdaq 100, which consists heavily of tech giants like Apple (AAPL), Alphabet (GOOGL), Nvidia (NVDA), and Microsoft (MSFT), has experienced a remarkable 43% surge in value this year. A contributing factor to this growth has been an expansion in the projected earnings per share for the coming year. The index currently trades at around 24.5 times forward per-share earnings, up from just under 23 times at the beginning of the year, according to FactSet data. It’s worth noting that this increase is partially driven by elevated earnings growth forecasts resulting from advancements in artificial intelligence, which are fueling greater demand for cloud services and computer chips.
Historically, rising bond yields have typically taken a toll on tech P/E multiples. For example, when the 10-year yield reached 4.2% in October 2022, the Nasdaq 100 traded at a P/E ratio of below 20. However, the current environment has seen tech valuations remaining relatively unaffected even in the face of even higher yields.
This resilience can be attributed to a couple of key factors. Firstly, Big Tech companies have been successful in reducing their borrowing costs through effective debt management practices. Additionally, their profitability has continued to grow, further boosting their equity valuations. By minimizing their reliance on high-interest debt and capitalizing on favorable borrowing rates, these companies have positioned themselves for success in the face of rising interest rates.
In conclusion, the unexpected upward trajectory of Big Tech stocks amidst rising interest rates can be attributed to their shrewd debt management strategies and sustained profit growth. By reducing borrowing costs and capitalizing on more favorable interest rates, these companies have defied historical trends and emerged stronger than ever.
Big Tech Companies Take Advantage of Low Interest Rates
Big Tech companies have recently taken advantage of low interest rates by refinancing their existing debt. In 2020, when interest rates were at a low point, these companies engaged in a refinancing binge, resulting in an average maturity for their debt of 12 years in the second half of the year, up from 10.5 years just months prior. This move has enabled them to lock in their borrowings at lower interest rates.
Furthermore, this refinancing spree has led to a reduction in overall rates for these companies. The average yield for growth companies on the S&P 500, predominantly composed of Big Tech firms, is now at about 3%, down from around 3.5% in early 2020 before the borrowing surge. This decrease in rates indicates that these companies are perceived as more credit-worthy, making it easier for them to repay their debt. As a result, more cash has the potential to flow to the bottom line for equity holders, increasing the price investors are willing to pay for owning these stocks.
Interestingly, the ability for these companies to secure such low rates is due to their increasing profitability. Not only have their profits outpaced the growth of their debt loads, but they have also managed their debts well. This fact is exemplified by Netflix (NFLX), which had a net debt of just under $10 billion in 2019, amounting to slightly over three times its earnings before certain expenses. However, after raising $1 billion of debt in 2020, the streaming giant’s net debt has decreased to just under $7 billion – an amount lower than the expected earnings before certain expenses for this year.
Despite the recent rise in the 10-year yield, these tech companies have remained resilient and their stocks have not been significantly impacted. Their ability to navigate through increasing interest rates further demonstrates their strong financial management.
- Jacob Sonenshine, s.com