"a high interest rate environment means that all that future growth has to be discounted back to a much lower net present value."
Could someone explain this to me like I'm a 5 year old (who understands what a discount rate and present value are, but not why that collection of words makes things harder for reddit)?
Reddit is unprofitable. They're telling investors: give us a dollar today and we'll give you ten dollars in as many years. (Hopefully.)
If interest rates are zero, that's a good deal. If rates are 25%, that $1 will almost get there on its own in a Treasury. A good deal in a low-rate environment is a bad one when rates, the price of money, are high.
Picking this one at random to reply to, but this goes to everyone: Thanks for all the replies.
I'm still confused. I think of inflation as a thing that devalues a present day $1. But as it applies to companies with revenue it seems like a rising tide that would lift all boats, and something that kind of divides out of the analysis of the future revenue stream of a company.
e.g. If Reddit's daily revenue is $x and inflation is 10%, then its daily revenue in a year is (approximately, caveats about their ability to raise prices, etc.) $1.1x. So Reddit can say "give us a dollar today and we'll give you $10 multiplied by ten years of 10% inflation in ten years". Is that mental model wrong?
I'm also confused why this problem particularly applies to Reddit, which seemed to the the implication of the comment I originally responded to. Is that just because Reddit makes a loss, and this challenge applies to all such companies?
I never understood why company like Reddit, which no users give a fuck if it is 50Billion or 250Billion valuations. It is kinda like Craigslist, it provides a benefit to the society as public forum for information sharing. The cost to run it shouldn't be too high. Just keep it running for the purpose of that. Don't get into those MBA talk about making it profitable. There are business that can be profitable. Something like a public forum, should be like digital public utility, kind alike park and public library.
It goes to stock pricing theory - you can basically say the total value of a company (all the shares added up) is the value of all the future profits, discounted back to todays dollars. If interest rates go up, we apply a bigger discount to reddit's future profits, so the value of reddit goes down. Since reddit is a growthy tech stock what we're kind of saying is reddit's biggest profits are a long way off so we're going to discount them a lot when interest rates are high, making reddit highly sensitive to interest rates.
If you understand what a discount rate is, you understand why higher interest rates decrease value. It's just math: the present value of x cash n years in the future at i discount rate is:
x / ((1+i)^n)
Discount rates are affected by interest rates, because interest rates represent what else you could do with your capital (you can always invest in a Treasury instead of a tech stock).
High interest rates mean more low-risk money in your pocket. Reddit needs to increase their growth rate to make sure the investment has a higher yield than interest+risk to make it valuable. Either you reduce present value or increase expected growth (which is significantly harder for tech companies).
Think of it as the opportunity cost. If interest rates are high, I can go out and buy a us gov't bond at x% risk free. This makes other investments that maybe looked attractive at lower interest rates less attractive now, and this is reflected in the lower npv value.
The safest investments are now giving higher interest rates than they did a year ago. So the expected future growth of reddit looks less appealing in comparison even if the company's prospects are unchanged.
One of the variables of a NPV calculation is the discount rate that corresponds to the risk profile of the investment being assessed. The lower bound on that discount is the treasury rate as that is what a USD investor deems "risk free". Therefore after a treasury rate hike, the discount rate for any given investment needs to be adjusted up and that lowers the NPV calculation result.
TL;DR the higher returns from US bonds make other investments comparably less attractive because you can get better yields from the USD bonds.
Could someone explain this to me like I'm a 5 year old (who understands what a discount rate and present value are, but not why that collection of words makes things harder for reddit)?