Navigating The Volatility In High Growth Stocks | 7investing
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Navigating The Volatility In High Growth Stocks

May 22, 2021

My portfolio has been wildly swinging several percentage points each day.

And it is not just what I personally own. Many companies on my watchlist are also off the highs, anywhere between 15% to 40%!

It sure appears there’s been a reasonable degree of pullback and increased fickleness in the market.

And yet, the S&P 500 index is only about 3% off from its record highs.

Where is the volatility?

Right now, much of the topsy turvy movements are in stocks of those companies that are largely regarded to be Covid-19 beneficiaries. We get a glimpse of this thinking when one looks at the Nasdaq 100 index. That index is down roughly 6% from its all-time-highs. Again, that isn’t much, but it is more than the fall in the S&P 500 index.

But the Nasdaq 100 index doesn’t really do justice because the pullback has really been concentrated in high-growth stocks coming off their ultra-high valuations. So, the likes of Twilio (NYSE: TWLO), MercadoLibre (NASDAQ: MELI), and Tesla (NASDAQ: TSLA) are off about 30% from their highs. And The Trade Desk (Nasdaq: TTD) has pulled back a whopping 40%.

What’s interesting is this: The sell-off is broadly in the high-growth companies category. The sell-off has come, in most cases, on the back of superb quarterly results, near-perfect execution, and despite bullish guidance. Many of these companies expect to see many years of ultra-high growth, yet there is a sell-off.

So what gives?

We could legitimately argue that some of the valuations had become stretched. A pullback grounds things. I always welcome that. That’s actually a sign of a healthy market, not a crazy euphoric bull.

So, if I agree with the current pullback, why didn’t I sell earlier?

In most instances, it is tough to know when the market decides to whack down valuation multiples. Sometimes, these types of investments can go up 100% or more before pulling back. Remember, I mentioned The Trade Desk earlier, which is off 40% from the highs. But guess what? That stock is still up 70% over the past 1-year and nearly 500% over 3 years. Planning when to get in and out of these companies can be a losing game!

So, instead of thinking about when the multiples might compress, I try to look ahead, at least a decade ahead and see if today’s valuations have the potential to deliver solid returns. More often than not, I am satisfied that Mr. Market hasn’t yet factored in the long-term potential. Thus, I’m okay to own the shares with the proviso that I am thinking long-term and accepting the volatility.

Combating volatility

When volatility strikes and my favorite ideas are down 15% or more from their recent highs, I pull out my watchlist.

In most instances, there is now a wider margin of safety.

I don’t know how much further some of the names might drop. I have no idea. Nada. Zilch!

But when attractive pricing is on offer, I’m all for adding to my positions, provided I am not over-allocated already. I even take these pullbacks as an opportunity to start minor and somewhat speculative positions.

In essence, I play offense, not defense, when the going gets tough.

The bottom line

If you regularly add money into your investment account and plan to do so for years to come, then a drawdown is a chance to buy more of the stocks you wanted to buy. Sure, when shares are up, we feel good about our portfolios, but we get to buy fewer shares for the same investment dollars when we add to positions. So, in effect, a pullback is excellent for the net buyer of stocks as we get to buy more.

And it is always instructive to remember that the market is a voting machine in the short term. Stocks go up and down for many reasons, which may not have anything to do with the fundamentals. But over more extended periods, the stock market is a weighing machine. Over longer timeframes, companies are valued based on their fundamentals. As long as one owns good-to-great companies and buys them at reasonable prices, we are likely to do well.