Growth stocks have largely been resilient over the last month or so. But rising bond yields could be a danger sign for shares that trade at high price-to-earnings (P/E) multiples.
I think this is something investors should take care of. While I’m not forecasting a stock market crash, being thoughtful about what to invest in is never a bad thing.
Bond yields
Since the start of the month, the yield on 30-year US government bonds has gone from 4.1% to around 4.5%. And the yield on UK gilts with the same duration has gone from 4.5% to 4.8%.
That means someone looking for a 30-year investment can get a 4.8% return just by buying bonds. And the risk is relatively low – the UK government is unlikely to not pay its debts.
Investing £10,000 at 4.8% would get me £14,400 over 30 years. So in order to consider anything else – shares in a business, for example – I’d need to think it could generate more than this.
The more bond yields increase, the more a company has to make for its shares to be investable at its current price. And the movement in the bond market puts pressure on growth stocks.
Nvidia
Nvidia’s (NASDAQ:NVDA) a great example. The company’s revenues and profits have been growing explosively and the stock is up 224% over the last 12 months as a result.
As I write, the current share price is $139. So for the investment to be a viable option, the business needs to be able to generate more than $6.25 a year on average for the next 30 years.
Analysts expect the company to generate a total of $16.85 in earnings per share between now and the end of 2027. By that point, the bond will have returned the equivalent of $25.
That means Nvidia’s going to have to grow – a lot – to justify its current share price. The big question is whether or not it’s going to be able to do it.
Are growth stocks in trouble?
None of this means that Nvidia shares – or growth stocks in general – are overvalued, or that they’re set to fall. And there’s a lot for investors to be optimistic about.
The company’s customers have extremely deep pockets. Whether it’s big tech firms or even nation states, I don’t think there’s much chance of demand dropping off due to pressure on budgets.
The big question, in my view, is whether or not the business can hold onto its competitive position. This is crucial to maintaining its high margins and increasing its profits.
The likes of Microsoft and Meta Platforms will know that Nvidia has a 54% operating margin. And I wouldn’t be surprised to see them investing in their own chip development to try and compete.
Investment returns
The higher bond yields go, the more businesses need to make to justify their current share prices. But growth stocks in general have been resilient over the last month or so.
This indicates that investors are optimistic about corporate earnings. In short, they still think companies will return more cash than bonds will.
This post was originally published on Motley Fool
