As rates rise, investors dump stocks of companies losing money

by Dave Sebastian | UPDATED Jan 18, 2022 05:30 AM EST

Changing Valuation Calculations on Companies That Don’t Make Profits

Moonshot stocks are coming back to Earth.

As the Federal Reserve moves closer to raising interest rates, investors are placing their bets on one of the riskiest corners of the market: stocks of companies that don’t make money. Cash-burning technology firms, biotechnology companies without any approved drugs and startups that list quickly through mergers with blank-check companies – some of which have soared during the pandemic – have declined sharply.

Data analysis from the Wall Street Journal shows that, as signals from Fed officials and continued high-inflation readouts made it clear that rate hikes were waning, shares of unprofitable companies in the Nasdaq Composite Index declined. , while their profitable counterparts generally still increase. Loss-making companies in the analysis lost an average of 25% from September 30 to Friday’s market close. Meanwhile, the profitable companies in the index rose an average of 1.4% for the same time frame.

The Journal’s analysis identified loss-making firms as having earnings per share below zero for at least the past four quarters. It excluded blank-check companies that have not merged with a target and some companies for which FactSet has not identified earnings-per-share figures for the most recent four quarters.

Fed officials have indicated they are accelerating their timetable to raise interest rates, possibly as early as March, to combat rising inflation. Many investors value shares based on the present value of companies’ future earnings. When interest rates rise, it becomes less attractive to place high-value bets on companies that may not be profitable for years to come, eating up that future value.

“Within our team, we’re considering, ‘Should we move out of some of these high-growth areas that may be susceptible to rising rates and look at weaker, undervalued areas of the market? ” “said Emerson Haim III, a senior partner at SoundView Wealth Advisors.

The performance of riskier growth stocks, which aim to deliver sharp profit growth in the future, lagged behind the broader index in late 2021. The Nasdaq CTA Internet Index, for example, has fallen nearly 16% from September 30 to Friday. , The Nasdaq Composite gained about 3.1% for the same time frame, while the S&P 500 gained 8.2%.

Hawkish Fed policy is driving a rotation toward stocks that generate higher-than-average dividend yields, said Jonathan Garner, a Hong Kong-based major Asia and emerging markets strategist at Morgan Stanley.

“It’s playing out on a worldwide basis, and we expect that to continue,” Mr Garner said.

Portfolio managers are also looking for exposure to financially sensitive companies, said Jordan Kahn, chief investment officer at ACM Funds.

“There will be some more calculations with some of these ultrahigh valuation stocks,” Mr. Kahn said.

Shares of some unprofitable companies soared earlier in the pandemic, when their businesses were boosted by lockdowns and social-distancing measures. Shares of e-signature software maker DocuSign Inc., which rose sharply at the start of the pandemic as businesses adapted to remote and paperless environments, hit an all-time high of $310.05 on September 3, but have fallen 58% since then. has gone. DocuSign has reported losses every quarter as a public company since its initial public offering in April 2018.

Shares of electric-vehicle maker Rivian Automotive Inc., which went public in November and posted revenue of $1 million and a loss of $1.23 billion for the third quarter, topped $172.01 in mid-November, but has since risen 54%. has fallen.

Robinhood Markets Inc., which became popular among individual investors during the meme-stock frenzy, maintains a loyal fan base and its shares have been volatile since their debut. After its IPO in July, shares soared to $70.39 in August, but they’ve fallen 78% since then.

The global race to vaccinate the world against Covid-19 sent stocks of biotech companies rallying during the start of the pandemic. But in the world of biotech, where clinical trials and regulatory decisions can make or break a company’s value, firms can spend years losing money while they wait for treatments to flow through their pipelines. Many people can never make money. The Nasdaq Biotechnology Index has fallen 14% since September 30.

Easing monetary policy has partially fueled the race for growth stocks, making it easier for companies to borrow cash at lower rates.

Greg Basuk, chief executive of AXS Investments, said of growth companies, “In a rising rate environment, it’s harder for them to borrow money and do other things to invest in growth.”

This route has also pushed companies debuting in the public market through special purpose acquisition companies, also known as blank-check companies, that seek to merge and go public. Raise money. Although one of Wall Street’s hottest trades in early 2021, the SPAC has fallen from its highs.

Electric-truck startup Nikola Corp, which went public through SPAC, fell 35% last year and fell 5.5% since September 30. The Defiance Next Gen SPAC derivative ETF, which tracks companies that have gone public through SPAC with SPAC that haven’t yet struck deals, fell nearly 26% in 2021 overall and is down 15% since September 30.

“For some of them, it may be bad fundamentals; There may be some pre-revenue companies that aren’t profitable yet,” said Sylvia Jablonski, co-founder and chief investment officer of Defense ETF, of the selling forces in the stocks of some growth companies. Some investors who have bought those companies. Retail traders such as fired prices have also taken a pause in SPAC investments and moved to other assets such as cryptocurrencies, Ms Jablonski said.

According to an analysis by Jay Ritter, a finance professor at the University of Florida, unprofitable traditional IPOs also delivered diminishing returns on day one in 2021. Pro. Nearly three-quarters of the more than 300 operating companies tracked by Ritter that went public in the US had earnings per share below zero, and they delivered an average first-day return of 30% in 2021, compared with a 45.3 % in comparison with. Small pool of companies in 2020.

While valuations are still bleak, the bar is high for unprofitable companies to deliver the results they promised, said Tim Murray, capital-market strategist for T. Rowe Price Group Inc.’s multiset division. Mr Murray said that amid the more challenging economic environment in 2022, investors are going to be more selective in investing in growth companies, profitable or not. He said he favors certain sectors, such as consumer staples and utilities, that will do well as the economy moves past its pandemic rebound and moves toward normalization.

Regarding nonprofit growth stocks, Mr. Murray said, “we’re probably even more selective and more concerned about that right now.” “Those stocks used to be much cheaper than they are now, and now the bar for them is already very high.”