Lost Money in the Technology Selloff? Here’s What Buffett Mentor Phil Fisher Says to Do.

It has been a brutal month or so for high-flying technology growth stocks that soared during the pandemic of 2020. In a massive market rotation, investors have sold off many high-growth stocks in software, electric vehicles, and other technology IPOs and special-purpose acquisition companies, in favor of more beaten-down sectors of the market like financials and energy stocks.

In particular, ultra-high-growth disruptors, like the kind favored by newly famous investor Cathy Wood have been hit particularly hard; her ARK Innovation ETF (NYSEMKT:ARKK) is down 21.7% just in one month:

XLK 1 Month Total Returns (Daily) Chart

XLK 1 Month Total Returns (Daily) data by YCharts

But if you’ve been a Foolish investor for more than just this brutal month, you’re likely an investor in one or more of these high-growth, disruptive companies, and still likely sitting on some big gains. After all, despite the sell-off, these types of stocks are up massively over the past year:

XLK 1 Year Total Returns (Daily) Chart

XLK 1 Year Total Returns (Daily) data by YCharts

After the past month’s rout, is the damage over? Or could this just be the start of more pain to come?

There’s a case to be made for both scenarios. But instead of focusing on what might happen next week, next month, or even this year, when everyone else is thinking short-term, it may be a good idea to focus on the longer term, and heed some advice from one of Warren Buffett’s greatest influences, Phil Fisher.

A woman cringes in front of her laptop in an office.

Image source: Getty Images.

High-growth technology stocks could be in for a tough year, even from here

Before we get to Fisher’s advice on selling stocks, it’s important to understand why the market has done what it’s done over the past month.

The COVID-19 pandemic of 2020 caused a big acceleration in the digitization of the economy last year. Thus, many high-growth software-as-a-service stocks, e-commerce stocks, and other internet stocks soared, as they helped power the economy through pandemic as people worked, educated, and even received medical care at home.

Think of it like squeezing a water balloon: As one part of the economy shut down (out-of-home stocks, travel stocks, banks), a lot of those dollars that would be spent in that part of the “balloon” flowed over to the other part (technology), inflating the technology sector’s results.

Many of these stocks were already terrific growth stocks, but their results were super-charged by the pandemic. High-flyers like Zoom Video Communications (NASDAQ:ZM) helped people communicate and meet from the comfort of home, and e-commerce juggernaut Shopify (NYSE:SHOP) helped small businesses and brands connect with consumers when physical stores closed. 

ZM 1 Year Total Returns (Daily) Chart

ZM 1 Year Total Returns (Daily) data by YCharts

At the same time, a good part of the “out-of-home” economy ground to a halt: 400,000 small businesses permanently closed, and millions of Americans lost their jobs. In response, the Federal Reserve dropped short-term interest rates to zero and stepped up purchases of long-term bonds, dropping the yield on long-term rates as well.

When interest rates decline, the value of stocks tends to go up, as each stock’s future earnings stream is discounted at a lower number. Therefore, when applying low interest rates and inflation expectations, future earnings aren’t discounted as much, thereby increasing their present value.

For high-growth technology, 2020 was thus the best of all possible worlds: Combine accelerating growth with low interest rates, voila! A massive spike in technology stocks in 2020.

As the pandemic ends, these trends are reversing

Of course, now that these trends are reversing, so too are investor appetites. Thanks to a quicker-than-expected vaccine rollout, it appears an economic reopening is close at hand, and with it, a lot of pent-up demand for “out-of-home” products and services. The massive $1.9 trillion American Rescue Plan was also just passed by the Senate, and will inject even more stimulus into an economy that’s about to reopen.

Not only could this reverse the flow of dollars from digital companies to “out-of-home” companies, but recent optimism has led to a spike in long-term interest rates as well.

While that is a great thing for the world, it’s very bad for technology stocks. In 2021, the digital disruptors that spiked in the pandemic could see their revenue decelerate pretty significantly. When you combine decelerating revenue with higher interest rates, that’s a nasty combination. So even after this month’s rout, there could be even more pain ahead for high-flying technology disruptors this year.

That leaves technology investors in a precarious position. What to do?

Buy, sell, or hold? Here’s what Fisher says

Say you own these growth stocks and are seeing lots of red ink in February-March. Should you sell your technology stocks and buy “out-of-home” stocks in travel, financials, and energy? That strategy could very well work out in 2021. But is it the right thing to do long-term?

Phil Fisher, one of the pioneers of a growth investing, advocated a concentrated portfolio of extraordinary companies, and then holding them for the very long-term. We’re talking holding periods of 10, 15, even 20 years or longer. That type of long-term orientation is one we advocate here at the Fool as well; however, in order to reap massive long-term gains, you have to endure some ups and downs.

Fisher’s seminal work Common Stocks and Uncommon Profits is one of the bedrock investing tomes of all time. Even Warren Buffett once said his investing philosophy is “85% Ben Graham, 15% Phil Fisher.” For Warren Buffett to include you in his essential investing philosophy is very high praise indeed.

So when everyone is freaking out about one week, one month, or even a year in the stock market, reading one of the best long-term investors of all-time is probably a good idea.

Fisher on patience and not selling — even if you think your stocks will decline

In executing Fisher’s Foolish long-term philosophy, there will inevitably be some periods in which a stock gets ahead of itself. When that happens, what should an investor do? In that situation, investors face somewhat of a lose-lose situation.

Fisher advocated that as long as the original thesis about the company is intact (that’s important!), investors should resist the urge to sell, even if one thinks the stock may go down or under-perform the market for a while.

Why hold on, even if you thin your stock will go down?

The reasons for this counterintuitive posture makes sense for the long-term investor. First, when you sell a big winner, you have to pay a lot in capital gains taxes. That could nullify some of the gains you would make from switching to another stock that may outperform for short periods in the near-term. Second, if you try to get out of a long-term winning business, with the hopes of buying back in at a lower price, you’ll often miss your chance.

Here are just a few quotes from Fisher illuminating these principles:

“If the growth rate is so good that in another ten years the company might well have quadrupled, is it really of such great concern whether at the moment the stock might or might not be 35% overpriced?”

“It is my observation that those who sell such stocks to wait for a more suitable time to buy back these same shares seldom attain their objective. They usually wait for a decline to be bigger than it actually turns out to be.”

“If the job has been correctly done when a common stock is purchased, the time to sell it is almost never.”

“If you are in the right companies, the potential rise can be so enormous that everything else is secondary. Every $1,000 I and my clients put into Motorola in 1957 is now worth $1,993,846 — after all the ups and downs of the stock and of the market… If I’d sold Motorola because I thought it was overpriced 10 or 15 years ago, chances are I would not have known when to get back in, and I would have missed a tremendous profit. If one of my stocks gets overpriced, I warn my clients that things may be unpleasant for a little while, but it will rise to a new peak later.”

Clearly, Fisher thinks that if you have winning companies that have run a bit ahead of themselves, it’s probably best just to hold on through a predictable downturn or correction. This is, of course, provided you share Fisher’s long-term oriented philosophy, and believe your stock to be a truly outstanding company. 

Notice, however, that this flies in the face of many professional investors’ institutional imperative to outperform each and every year. Professional money managers often have a conflict in which they fear short-term underperformance, so they go in an out of stocks to avoid that outcome. After all, just a brief period of under-performance may cause investors to pull out of one’s fund.

Ironically, this puts individual investors, who only have to answer to themselves, at an advantage.

But there’s a caveat here — don’t just hold any stock forever

Of course, Fisher also gave his three reasons that you should sell a stock. After all, no one is advocating holding everything you own forever. The three reasons include:

  1. If you’ve concluded that you’ve made a mistake.
  2. The stock no longer qualifies with reference to his “15 points,” checklist — basically, if the company’s industry, management, growth prospects, or strategy have changed since the original purchase.
  3. A more attractive opportunity in another stock is identified.

Aside from these fundamental reasons that have little to do with the current stock price, basically, Fisher is advocating holding strong through periods of volatility, provided that you’ve analyzed the stock, and it still qualifies as an outstanding company.

While I won’t go through all of Phil Fisher’s 15 points, they tend to relate to a company’s competitive advantage, the size of its potential market, management’s ability and goals to innovate new products and services and enter new markets, expand margins, and other qualitative concerns.

So if you’re sitting on big technology stock losses, ask yourself: do I really believe in this company? Do I think its products, services, and market potential are unchanged from when I bought it? Or did I just buy the stock because others said to, and it was going up?

As another great investor Peter Lynch once said, “You have to know what you own, and why you own it.”

So as long as you’ve done your homework, still believe in a company’s products, management, and long-term market opportunities, Phil Fisher would advocate having a strong stomach and to just holding on through this unpleasant period. Looking beyond 2021 to five, 10, or 20 years out from now, if you’ve picked the right company, odds are you’ll be thanking yourself for holding strong today.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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