What a crazy year 2020 has been!
In what was possibly one of worst health and economic crisis we have ever seen in recent memory brought on by the COVID-19 pandemic, we have also seen some of the most astounding movements in the US stock markets that dipped into bear territory that quickly rebounded into a bull run within the space of 2 months and closing the year on record highs.
Here is how each of the major benchmarks did in 2020:
| Index | YTD Price Return 2020 | YTD Total Return 2020 |
| DJIA | 7.2% | 9.7% |
| S&P500 | 16.26% | 18.4% |
| NASDAQ | 43.6% | 45% |
It is clear that the rise of the stock market has largely been driven by the tech sector as seen by the astounding returns of the tech heavy NASDAQ as compared against the other indices.
So in reviewing the year that was 2020, I would like to share 5 key lessons / observations that I believe is instructive for investing in 2021 and beyond.
1 – A Little Tech in the Portfolio Goes a Long Way
Aside the obvious massive outperformance of the tech heavy NASDAQ in 2020, I think it is also worthwhile and instructive to take a look at an “old-school” index like the Dow.
Looking at the Dow, it has roughly 13% allocated to the tech sector. This came after a rebalancing of the index in August 2020 where it saw Salesforce.com Inc. (NYSE:CRM), Honeywell International Inc. (NYSE:HON) and Amgen Inc. (NASDAQ: AMGN) replace Raytheon Technologies Corp (NYSE:RTX), Exxon Mobil Corporation (NYSE:XOM) and Pfizer Inc. (NYSE:PFE).
As it turns out, this move has ultimately contributed some ballast to the index and have enabled positive returns for the year in spite of disastrous showings from constituents like Boeing Co. (NYSE:BA), Coca-Cola Co. (NYSE:KO) and Chevron Corporation (NYSE:CVX) for the year.
It is instructive to understand how even a conservative / income focused portfolio can in fact benefit with diversification into tech. And the best part? This diversification can be achieved without anything super speculative.
A little into stalwart blue chip tech can go a long way for the health of one’s portfolio.
2 – Be Prepared for Volatility
While it is true that business in the tech sector has experienced some truly astounding tail-winds brought about by the pandemic that in turn justifies the spectacular performance of tech stocks in 2020, it is also prudent to recognize that the valuation for tech stocks are VERY stretched. One of the most hotly anticipated IPO in the tech space Snowflake Inc. (NYSE:SNOW), started trading at a valuation that is well above 200 Price-to-Sales ratio mark (!) when it debuted.
It is important to understand the various factors at play.
Year 2020 has seen a tremendous amount of liquidity injected into the economy via “stimulus packages” from various governments around the world that is also coupled with record low interest rates. It is also important to recognize that the pandemic induced economic crisis is not one that has been caused by slowdown in demand but rather due to health fears and enforced shutdowns.
If we put it all together, this is a formula that leads to a general inflation of asset prices. A sense of this can be seen by looking at traditional hedges against the stock market like gold actually appreciating in tandem over the year.
Ultimately, prices are a function of supply and demand. At the moment, tech stocks in high demand. In this environment, there is a lot of uncertainty in valuation which translates to high-running emotions in the market. This is very likely to manifest itself in stock price swings one way or other in the foreseeable future.
A rising tide raises all ships. For investors who are keen to add / or already have some tech exposure in their portfolio, it would be important be level-headed and to not be too carried away by over-optimism.
3- Where there is Misunderstanding, there is Opportunity
A big part of what contributes to the volatility in tech stocks is the fact that technology or the business opportunities in itself is often easily misunderstood. It is therefore easy to either underestimate or overestimate the business, moat and prospects of any given tech company and in turn lead to some pretty dramatic reactions.
We have in fact seen this happen to several high-flying tech stocks in 2020.
Take for instance Fastly Inc. (NYSE:FSLY) who have seen their stock crash twice in single year. The first decline of about 31% was primarily driven by a disclosure made during their earnings call pertaining to TikTok who is contributing to ~12% of their revenue at the point in time being at risk of being banned from operating in the US. The second decline of about 51% was again related to TikTok where it was disclosed during the quarter’s earnings call that TikTok have by then switched off most of their usage of Fastly’s services due to the lingering effects of the US ban.
When confronted with a situation like this, the instinct is to ask the question – “Why did it crash?”. This would likely result in a rush to scour for news / headlines that reveal negative upon negative news. Perhaps, in a state of panic, one would then exit the position. Sounds familiar?
Now, what if one can stay calm and assess the situation with further questions like, “Is the impact of TikTok slowed growth of the company down to the point that it is irrecoverable?” and “Does the long term prosperity of the company really hinge on TikTok?” Asking follow up questions like these may lead one to view the situation differently and drive different actions altogether.
You see, the outcome of the assessment is not the main point in the example above. Rather, the process of learning how to calmly assess and frame follow up questions that reveal insights is key. By applying the process consistently will ultimately help you to build conviction for your investments and tolerance for volatility.
As it turns out, what happened with Fastly isn’t unique or even rare. I remembered the day when the COVID vaccine was announced in November 2020 that triggered sell-offs in the tech sector, likely fueled (at least in part) by optimism of things going back to normal and tech stocks will be adversely impacted.
As I’ve said before, tech is typically complex. This leads to a lot of uncertainty and hence volatility. This also means there are plenty of opportunities to invest at decent or attractive valuations. Of course, you will need to first have the conviction to pull the trigger when the opportunity presents itself.
4 – Watch Your Allocations
The attractiveness investments in tech companies is in the potential for explosive and profitable scale. A tiny tech upstart today has the potential to grow to be a behemoth. In turn, the returns for early investors into these upstarts can be life changing, even if it was with just a small investment upfront.
Netflix Inc. (NASDAQ:NFLX) for example had returned almost +500X to IPO investors over the span of 18 years. While impressive, it is also worthwhile to understand that the Netflix of today is VERY different from when it first IPO. Netflix being a video streaming giant today really only began in earnest circa 2011 – 2012. Investing in Netflix during their IPO days in 2002 was a very different proposition (their main business being around sending DVD out by mail).
There are many lessons to takeaway here, but the three key things are:
- It is often worthwhile to allocate some capital in the portfolio to shoot for the moon, especially in the tech space if the right opportunities are identified
- Maximum rewards are usually found in early stage growth companies that typically carry higher risk
- Such investments does NOT have to be a big part of one’s portfolio for it to be impactful in the long run
The year 2020 saw a flurry of tech companies come public via IPO / SPAC that could be viewed as exciting opportunities for investors to be involved from the “ground floor”.
However, you need to recognize the inherent risk and balance that risk by allocating capital prudently if you were to participate. Risk-reward ratio management is an important discipline, so never bet the farm!
5 – Stay Invested for the Long Haul
If I can boil things down to three most important aspects to evaluate for successful growth investments in the tech space, it is really down to the value proposition of the technology, its corresponding market opportunity and the company’s execution.
The most important element that allows investors to assess these aspects is time.
Taking again from the example of Netflix; for most of its existence in the public markets, its stock has experienced a lot of volatility and returns across a decade has been more or less flat. Understandable given its original incarnation of being a “DVD-by-mail-delivery” business. However, even when it has started evolving into delivering video via online streaming circa 2011-2012, it took nearly 3 years for its stock price to truly take-off.
Why?
Well, at the very fundamental level, it takes time for Netflix to prove out the value proposition of online video streaming (which was a significant innovation back when broadband Internet was still in its infancy), its corresponding market opportunity (which expanded to potentially anywhere in the world) and its ability to execute (transit into this new business model without collapsing entirely). Investing early back then means assuming more risk and uncertainty, but as you can see, with the passage of time, the thesis proved out and stock appreciation followed. Today, it is on a new leg of growth.
So if you’d ask me today, how certain stocks will perform in the coming years, I honestly wouldn’t know. For any one of my growth stock holdings in the tech sector, I can only tell you two things:
- That I have an investing thesis that leads me to believe that they can be quite a bit bigger than from where they are today
- That so far, the company’s execution is demonstrated to be on point.
If a company is growing profitably, stock price appreciation will very likely follow. If things change along the way for the worse, I then exit. Else, reassess or revise and take corresponding action. In a very simplified sense, that’s really all that matters.
After a year of mind-boggling returns in 2020 for the tech sector, it is more important than ever to cultivate patience for the coming years and focus on the business rather than the stock price.
Summary
So here we are at 2021 and I hope that you have managed to catch and benefit from the tech tailwind in your investments from a wild 2020. Given the swathes of emotions (i.e. FOMO) running high in the markets alongside uncertainties of the global economy at large, prudence and emotional control is well advised. Here is wishing you good luck on your investment journey into the year ahead (and far beyond!)
Disclosure: The author owns shares of Microsoft Corporation (NASDAQ:MSFT), Salesforce.com Inc. (NYSE:CRM), Snowflake Inc. (NYSE:SNOW) and Fastly Inc. (NYSE:FSLY). Investors should conduct their own due diligence before engaging in any buying / selling of any of the shares mentioned.