Inflation Is Eating Into Profits And Valuations

Sebastien Callebaut -

Valuation Cuts Within Venture Capital

The fortunes of investors riding a 13-year bull market are being shattered by a dizzying reversal in technology-startup financing. The new climate has quickly brought high-flying businesses to a halt: layoffs, cautious investors, a fund outflow, and the threat of a valuation cut.

  • The reversal coincides with a shift in the broader IT industry, where stocks are plummeting and businesses ranging from Meta Platforms to Twitter and Uber are cutting costs
  • After years of putting profitability on the back burner in favour of expansion, venture capitalists are now demanding that companies spend less and increase their margins

Bubble Bursting Within Technology Stocks

When the pandemic began more than two years ago, technology businesses thrived. However, as more people return to work and spend less time at home, the tech sector is seeing significant losses as investors fear that companies boosted by the pandemic are losing momentum.

  • In the last weeks, Big Tech has lost over $1 trillion in value, as many of the world's largest corporations are still reeling from the repercussions of missing earnings forecasts
  • Wall Street is doubting Big Tech's ability to maintain the momentum needed to justify high valuations fuelled by the pandemic's extraordinary demand for new technology

And it doesn't end there. Economists believe the rapid rise in interest rates has prompted investors to reconsider whether equities that thrived in a low-interest environment will be able to thrive in a higher-interest climate. Tech companies tend to perform worse when interest rates are higher and financing is more expensive.

  • Deutsche Bank is predicting a major recession in the United States by 2023, asserting in a client report that it is “highly likely that the Fed will have to step on the brakes even more firmly, and a deep recession will be needed to bring inflation to heel.”

High Costs Are Eating Into Corporate Profits

Target's stock tumbled over 25% on Wednesday after the retailer disclosed quarterly profits that fell significantly short of analyst projections, owing to inflation, supply difficulties, and shifting consumer habits.

  • The company made a $1 billion profit in the three months ending in April, almost half of what it made in the same time a year ago. Revenue, on the other hand, climbed by 4% to $24.8 billion in the quarter
  • Rising sales and a profit that is halved point to the strong impact of inflation and of Target's difficulty to pass on price increases directly to consumers
  • Target predicted sales will continue to expand at a similar pace this year, but it cut its profit forecast, alarming investors

“Throughout the quarter, we faced unexpectedly high costs, driven by a number of factors, resulting in profitability that came in well below our expectations, and well below where we expect to operate over time,” Brian Cornell, Target’s chief executive

BENCHMARK'S TAKE

  • The rally at the start of last week was traded on very thin volumes and did not suggest a broader recovery
  • Inflation is a powerful force as it eats into corporate profits and increases yields, making it harder for consumers to borrow
  • For now, we expect the Fed to continue its lightning tightening and further pressure stocks, private assets and real estate... leaving no place to hide

Disclaimer

Please note that this article does not constitute investment advice in any form. This article is not a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.

Credits

Photo by Yassine Khalfalli on Unsplash.