The pandemic created chaos in many industries in 2020. Yet some businesses have quickly adapted to the new environment and thrived, despite the disruptions to operations. Many of these companies can be found within Scottish Mortgage Investment Trust’s (LSE:SMT) portfolio of stocks. So it’s not surprising that the Scottish Mortgage share price more than doubled last year.
But over the past few weeks, the price has experienced a significant tumble of 30%. What caused this price collapse? And is this a buying opportunity for my growth portfolio? Let’s take a look.
Growth stocks are driving the Scottish Mortgage share price
The core business model of Scottish Mortgage is to invest in companies on the stock market and then reward its shareholders with the profits it generates. This means that its share price is primarily driven by the underlying performance of the companies it owns.
The top five positions within its portfolio today are Tesla, Amazon, Illumina, Tencent Holdings, and NIO. In 2020 all of these stocks saw explosive growth. But recently, they haven’t been doing so well. As far as I can tell, the market, in general, has been falling for a few weeks due to the concerns surrounding rising inflation. Why does this matter? Let me explain.
How inflation affects stock prices
Inflation can have a complex effect on the stock market. But generally, when it increases, so do interest rates. This makes fixed-rate bonds looks significantly less attractive to their variable-rate equivalents. And so money is moved out of the first and into the latter (or into other low-risk higher-yielding investment instruments).
But as a consequence, fixed-rate bond yields begin to increase as well. This is precisely what happened with the 10-year US Treasury bond, whose yield doubled within the space of six months. Subsequently, the higher payouts begin to attract additional investors, including those currently invested in the stock market.
When this happens, growth stocks tend to be the ones that get sold off first. Why? Well, without going too far off the beaten track, when inflation rises, the net present value of future cash flows falls. Put simply, the value of the expected future returns of a stock loses value. And so shares with high valuations, like those in Scottish Mortgage’s portfolio, begin to look even more expensive.
Is this a buying opportunity?
The fall in Scottish Mortgage’s share price doesn’t concern me. Even after this crash, it’s still up around 90% on a year ago. And the companies in its portfolio look to have strong prospects that could drive it higher. But that doesn’t mean there aren’t any risks to consider.
Many of the stocks in the portfolio have absurdly high valuations driven by shareholder expectations. For example, Tesla, which is 9% of the portfolio, is currently trading at a P/E ratio of 1,080! Needless to say, if Tesla fails to perform, its share price could come crashing down and significantly impacting Scottish Mortgage in the process.
Investing in high-growth stocks undoubtedly carries an increased level of risk. And there’s no way of knowing when the fears surrounding inflation will cease. But overall, even with the elevated risk level, I feel the recent drop in share price looks like a good opportunity to add the firm to my growth portfolio.