Lower Inflation Benefits Start-ups

3 Mins read

Lower inflation is not only a favorable situation overall, but it particularly holds significant advantages for start-up businesses such as Nikola, Fisker, and Rocket Lab USA, among others.

Hot Stocks on the Rise

Examples of thriving stocks are not hard to come by. For instance, shares of Nikola, a manufacturer of battery and fuel cell-powered trucks (ticker: NKLA), have experienced an impressive increase of nearly 17% in late trading. In comparison, the S&P 500 and Nasdaq Composite have risen by approximately 0.8% and 0.9% respectively.

Furthermore, the stock prices of two electric vehicle (EV) start-ups, Fisker (FSR) and Lordstown Motors, have surged by 4.5% and 4.1% respectively. Additionally, Battery technology company QuantumScape (QS) has seen its shares rise by about 15%.

It’s worth noting that the electric vehicle sector is not the only one witnessing a boost. Rocket Lab USA (RKLB) has observed a growth of almost 13% in its stock value, while shares of lidar maker Luminar Technologies (LAZR) are up by approximately 7%.

The Role of SPACs

All of these companies have joined the ranks of publicly traded stocks through mergers with special purpose acquisition companies, commonly known as SPACs. However, despite their successes, none of these companies currently generate free cash flow and rely on external financing to fuel their expansion.

Beyond SPACs

The rally in the market is not confined solely to SPAC stocks. For instance, Rivian Automotive (RIVN), which raised funds through a traditional IPO, has witnessed an impressive surge of almost 10% in its shares. Like other players in the industry, Rivian also requires external financing to sustain its growth trajectory.

The Impact of Lower Interest Rates on Start-Ups

With the recent widespread gains in the market, it is clear that the catalyst behind the rally can be attributed to macroeconomics rather than any specific company event. One key factor contributing to this overall growth is the lower inflation rate in the United States. While consumer prices have risen by approximately 4% year over year, this increase is slower than what economists had predicted and also slower than the rise experienced in April.

The significance of slower inflation lies in its impact on the Federal Reserve’s decision-making process regarding interest rates. With inflation rates remaining low, there is less pressure on the Federal Reserve to raise interest rates. In fact, a decrease in interest rates may even be imminent. We have seen before that after rates rise, they eventually come back down.

Lower interest rates bring about several benefits for start-up companies. Firstly, it becomes more cost-effective for start-ups to secure funding and begin their operations. For example, if a company needs a $1 billion loan to kickstart its business, it is obviously more favorable to pay a 3% interest rate instead of a 6% interest rate.

In addition, lower interest rates make start-ups more appealing to investors. When traditional yield-paying investments only offer modest returns of 2% or 3%, investors tend to seek out more speculative opportunities with high-growth potential, hoping to achieve significant capital gains. Furthermore, by choosing to invest in start-ups, investors can also avoid the burden of having to pay a sizable percentage of the bond balance as interest payments.

Beyond funding and investor interest, lower interest rates also have a positive impact on start-up valuations. As most start-ups generate earnings and cash flow in the distant future, the projected value of this cash flow is enhanced when interest rates are lower. When calculating the fair price for an investment, lower rates result in a higher present value for future cash flows. On the other hand, the effect of higher rates on the valuations of well-established businesses is not as severe, as a significant portion of their cash flow is already being generated in the present.

In conclusion, the combination of lower inflation rates and the potential for decreased interest rates is driving the growth of start-ups. This favorable environment not only reduces the cost of starting a business and increases investor interest but also enhances the valuation outlook for start-ups by assigning a higher value to their future cash flows. As a result, start-ups are well-positioned for success in the current market climate.

The Opportunity to Nibble on Stocks

Given the significant downturn in stock markets, the prospect of lower inflation emerges as a compelling reason to consider taking action.

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