Growth stocks do well in lower interest rate environments because their future earnings are worth more today when discounted at a lower rate, making their valuations rise. Additionally, lower borrowing costs and greater investor appetite for risk also benefit these companies.
1.Valuation Mechanics: Discounted Cash Flow (DCF)
Growth stocks — like those in tech or biotech — are priced largely based on their future earnings potential, not what they earn today.
Here’s how it works:
Analysts use a Discounted Cash Flow (DCF) model to estimate what a company is worth today.
The formula discounts future expected cash flows back to today’s value using a discount rate, which includes the risk-free interest rate.
Lower interest rates → lower discount rate → higher present value of future cash flows → higher stock valuation
Since growth stocks often have cash flows far in the future (because they reinvest heavily now), they benefit disproportionately from a lower discount rate.
2.Cost of Capital Drops
When interest rates fall, the cost of borrowing goes down — not just for individuals, but for companies too.
Growth companies often take on debt to fund expansion, R&D, or acquisition. These companies aren’t yet profitable and need capital to operate.
With lower rates, it’s cheaper to raise capital (via debt or equity).
Expansion and innovation become more affordable for growth companies.
Profitability timelines get closer, or appear more certain
This improves their business outlook, which the market rewards.
3.Investor Behaviour Shifts Toward Risk Assets
In lower interest rate environments, investors rotate out of safe assets and into higher returning assets.
Growth stocks become more attractive compared to low-yield bonds or cash.
This increased demand for growth stocks pushes up prices.
Lauren Hua is a private client adviser at Fairmont Equities.
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