With stock markets making new highs this year, it is a good time to look back at the lessons learnt from the collapse of some tech stocks in 2021 and 2022.
Back then, stock markets also reached all-time highs but many tech names collapsed as valuations compressed and growth stalled.
With this in mind, here are some of the key things to be mindful of today as we navigate the stock market.
Don’t celebrate too soon
Investing is a long game. Just because our stocks have risen does not mean we have won the game. The true test of a business’s strength is its enduring ability to keep on growing. Stock prices may also reflect unwarranted short term optimism which does not materialise.
Make sure to continuously assess the fundamentals of your portfolio companies even (especially) if its stock price has skyrocketed.
Don’t chase stocks
It may be tempting to buy stocks that have risen greatly in a short period of time. Afterall, none of us want to be left out of a massive rally.
But this fear of missing out can work against us as stocks don’t keep going up forever. Remember that valuations matter and we need to assess if a stock has gone up too much over a short period of time.
In 2021, many stocks rose to unsustainable valuations, only to come crashing down to earth in the next two years. While some have recovered, many still linger up to 90% off their all-time highs.
Sell if valuations don’t make sense
Buy-and-hold is a great strategy when markets are working smoothly and you’ve bought into great growing companies at reasonable valuations.
But when stock markets are not working well and stock prices rise too high due to unwarranted exuberance, it may be important to look at your sell strategies.
Back in 2021, the stocks of many companies skyrocketed. It was not uncommon to see stocks rise by up to 1,000% in a short period of time.
While some of these companies are undoubtedly growing fast and are resilient, the valuations reached a point where forward returns would likely be depressed. Unsurprisingly, many of these companies’ stocks plunged and have yet to recover.
Growth trends may not continue
It may be tempting to look at a company’s recent revenue and profit growth and assume that it can continue growing at that rate for a long period of time. The reality is that future growth trends may not always mirror the past. This is especially true for companies that have been growing at unsustainably high rates. More often than not, growth will fall back to more normal rates.
The poster boy of the COVID collapse is probably Zoom Communications. The company saw explosive growth, only for its growth rates to flat-line once the pandemic ended.
Besides Zoom, there are numerous other companies that also saw growth decelerate meaningfully as we exited the pandemic era.
These companies unsurprisingly have seen their stock prices collapse.
Look for recurring revenue
Many companies can experience significant upmarkets due to upgrade cycles or loose monetary policy which encourage unsustainable consumer and business spending. However, remember that many companies do experience significant swings in revenue because of the cyclical nature of their end-demand. This may be more true for hardware companies or those that sell big ticket items.
Companies such as Enphase, which sells solar power products such as microinverters, have seen their revenues crater as distributors struggle to clear inventory because of weak end-customer demand.
Bottom line
Although it is nice to see stock prices rise significantly in the past two years, it is important that we remember the key tenets of value investing. The above mistakes are some that many of us have made before.
This time around, let’s try to ensure that we maintain a portfolio of stocks that have good valuations and whose business can continue to thrive in good times and in bad.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I have a vested interest in Zoom Communications. Holdings are subject to change at any time.