Netflix and Tesla will withstand higher debt yields worse

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Netflix and Tesla will withstand higher debt yields worse
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Facebook, Apple and Alphabet have more free cash flow in the short term

Rising returns on US debt are often the enemy of technology investors. But some companies have less to fear.

The higher the benchmark returns go up, the lower the value of the future free cash flow. So stocks have fallen as inflation concerns and the prospect of tighter monetary policy have pushed the 10-year bond above 1.6%, from 1.3% in mid-September. Morgan Stanley expects further increases, up to 2% in mid-2022.

The hit to valuations could be dramatic. The S&P 500 firms will collectively generate $ 1.3 trillion of free cash flow this year (excluding banks and other companies with no estimates). They have a combined value of 39 trillion. Assuming 2% growth in cash flow, in line with the Fed’s long-term GDP forecast, the implicit discount rate is 5.5%. If it goes up to 6%, the combined value would fall 15%, using the present value formula. Tech companies whose best days are in the distant future would do even worse.

But some of today’s fast-growing tech giants also have prodigious short-term free cash flow. Facebook will generate 133 billion cash in three years. At a 5.5% discount rate, the current value is $ 123 billion – 14% of its business value of $ 866 billion. The same ratio for S&P 500 firms is 11%. That is, more of Facebook’s valuation is supported by short-term free cash flow than the market as a whole. The same is true of Apple and Alphabet, whose three-year flows would add up to 12% of the current value. That gives them a bigger cushion if rising returns scare off equity investors.

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It is the opposite for Netflix and Tesla, whose ratios would be 1% and 2%. Uber also appears vulnerable, at 2%. Its high valuations are based on distant hopes. As discount rates rise, illiquid tech companies have the most chance of crashing.