Friends,

Last week, we talked about how the 10-Year treasury was the highest its been in nearly two decades. And yes, as we said last week, that sounds pretty boring.

But it's also incredibly important. When the 10-Year is getting higher, that's usually means borrowing costs are getting higher for everyone, and inflation is becoming a problem. When those issues converge, other dominos can start to fall.

If a stock you're invested in has one (or more) of these characteristics, then it's worth being aware of the added risks cropping up.

Heavily indebted companies

This one should really not be a surprise. Last week, we saw shares of some of the most heavily indebted companies -- like the Big Three Neoclouds of Nebius, Coreweave, and IREN -- plummet an average of 25%.

It makes sense: while demand for AI compute is indisputably high, the costs of building data centers, buying the GPUs that run inside of them, providing energy to run them, and cooling the entire operation is ridiculously expensive.

All three of these companies rely on cheap-enough money to continue their buildout. But when the cost of borrowing goes up, investors start having their doubts.

High-Beta Companies

We love running reverse discounted cash flow (rDCF) analyses on our favorite stocks. The reason: instead of spitting out a stock price that's fair, it spits out a growth rate that the company needs to accomplish to justify today's stock price.

But one of the key inputs to an rDCF is a discount rate: the amount that you hypothetically want your stock to go up each year. Usually, we just punch in 10% -- that's the long-term average of the S&P 500 over hte past century-plus.

In a rising rate environment, however, that math changes a bit. The textbook way of calculating the discount rate is as follows:

• The equity risk premium (the reward you get for investing in stocks) currently sits at 4.20%.
• A company's beta is how volatile it is versus the S&P 500.
• As we talked about last week, a rising risk-free rate means you have to earn better-than-average returns for it to be worth taking a risk on stocks when you can get 5.2% on bonds for no risk.

For a company like optics-focused Credo Technologies, it wreaks havoc on the level of growth necessary to justify the stock price. Consider how much higher the discount rate gets.

Perhaps it's no surprise, then, that Credo was also down 22% last week alone.

Companies Counting on Back-End Heavy Cash Flows

Axon Enterprise has a lot going for it. The taser, body camera, and software-for-police player has been growing sales at an average rate of 30% for a decade -- and that growth rate is accelerating.

But it's not perfect. Because Axon is investing aggressively in AI tools, drone tools, and international expansion, it is plowing most of its gross profits right back into investments for the future.

That's a smart move, but it means that cash flows are much lower right now than they would be if profits today were the focus. In fact, while we believe Axon could have 25% to 30% free cash flow margins in the future, it only has 4% margins today.

Here's why that's a problem: the vast majority of cash flows necessary to justify Axon's price are coming 5 to 15 years from now. Before interest rates started going up, they were being discounted at about 10% for Axon. But today, they're over 11%.

That might sound like a small difference. But if Axon earns $10 billion in free cash flow fifteen years from now, look at how much it's worth today at different discount rates.

• 10% discount rate: $2,059 billion
• 11% discount rate: $1,741 billion

That's a 15% drop in potential value just because interest rates went up. Of course, this same math plays out with all companies. But those that are relying on the majority of their cash flows to come years from now carry a heavier burden.

None of this is to say you should avoid these companies. In fact, I (Stoffel, here) count Axon as one of my largest holdings. But it does mean that understanding the lay of the land matters. And currently, rising rates are changing that landscape. Keep your eyes open and focused on the long-term, and you'll be able to navigate these changes.

Wishing you investing success,

Brian Feroldi, Brian Stoffel, & Brian Withers Long-Term Mindset

One simple graphic

One piece of timeless content

A high dividend yield can be a gift or a trap. Dave Ahern shares the three-step test he runs before buying.

One resource

AI agents could cut out middlemen like Booking.com and DoorDash. UncoverAlpha breaks down who's most at risk.

One Stock Dive

Here's a one-page overview of how I rated SEA Limited (NYSE:SEA) in Stock Simplifier.

One quote

👋 This newsletter was...

​🧠🧠🧠🧠🧠 Awesome!​

​🧠🧠🧠 It was OK​

​🧠 Do better​