In this segment of “The Morning Show” on Motley Fool Live, recorded on Dec. 13, Fool Director of Small Cap Research Bill Mann and Senior Analyst Jim Gillies discuss one of the main reasons why people invest.
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Bill Mann: Do the Motley Fool’s investing methods work during a rising rate environment considering you invest based on future cash flows versus present cash flows?
I’m going to say something that’s probably pretty extreme, but directionally correct. Everyone invests on future cash flows, whether you know it or not. Even asset-based investors. Investing is all about the future earnings of the company discounted back to today.
Now the discounted back to today part is important, because the higher the interest rates, the higher the discount. Because in a zero interest rate environment, if I lend Jim Mueller, a perfectly good credit risk, $100, I’m going to ask for a $101 next year.
But in a high-interest rate environment, a high inflation environment. I’m essentially costing myself money, so it would be next year I would ask him for $106 back. Has nothing to do with Jim, Jim’s the same exact credit risk, but that’s the environment that we’re in.
Future cash flows are valued less today in a higher interest rate environment. Does that hurt growth stocks? The stocks. Undoubtedly, yes. Our methods, what Jim just showed you work because they don’t work all the time.
Jim Gillies: Agree. The Joel Greenblatt explanation for The Little Book That Beats The Market. It beats the market because it doesn’t always beat the market.
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