For multibaggers, you NEED volatility

Debunking the bad rep of volatility

In this article

These are some of the points we will touch on in this article.

• For me, volatility is not risk and often volatility is necessary to have big gainers.

• What is risk exactly? We look at the definition and apply it to the concept.

• How you should react to volatility.

• Chris Mayer identified 365 stocks that went up 100 times and more and all (all!) of them had drops of more than 50%. We look at a few examples.

• All future stock market crashes look like threats, but all past crashes look like opportunities. Think ahead!

For some of you, this article might be familiar, as it is an adaptation of an article I published two years ago on Potential Multibagger . Since then, it’s in the Getting Started section there, as I think it’s fundamental for my approach and that’s why I wanted it to share it with you here too.

Introduction

High volatility is completely inherent to high-growth stocks. Huge spikes and big drops are a part of the journey if you look at stocks that can multiply a few times over.

Volatility does not equal risk, though, no matter how hard pundits try to convince you of this. In this article, I will explain how I see risk and how volatility is often necessary to have big winners.

What is risk?

Wikipedia defines risk like this:

In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environment), often focusing on negative, undesirable consequences. (...)

The understanding of risk, the methods of assessment and management, the descriptions of risk and even the definitions of risk differ in different practice areas (business, economics, environment, finance, information technology, health, insurance, safety, security etc).

As you can see, the term itself is simple. It's the possibility of something bad happening. If you look at the second paragraph, though, it's getting more complicated again and several definitions of risk in several contexts exist.

I use the simple, centuries-old definition of risk. For me, risk means how likely it is that you will lose your money in your investment over an extended period of time. You can discuss what is long-term, of course. But I’m a follower of Buffett here: “If you don't feel comfortable owning a stock for 10 years, you shouldn't own it for 10 minutes.” You also know that other famous quote: “Our favorite holding period is forever.”

Now, in reality, about 30% of Buffett’s holdings have been in his portfolio for 10 years. That’s because things can change fast in business: new competitors, bad money allocation, broken promises and so on.

So, let’s agree that the long term is 10 years or more. That’s the investment horizon I strive to have, even though there will be stocks I sell earlier.

Let’s get back to risk. There is a consequence to my old-fashioned definition to risk. It means that for me, risk is NOT quantifiable. Quantifiability is why many market pundits choose to equal volatility and risks but I see this as the proverbial man with the hammer who sees nails everywhere. You can perfectly measure volatility, with beta, for example, but it doesn’t tell you much about risk.

Volatility and how to react

As a long-term investor, you can develop a competitive advantage over almost all other investors. Now, this has become very clear again. The edge you have is simple but very hard: learn to sit on your hands through drops. Or better: add more to hated stocks if the company keeps performing, your conviction is high and your position is not too big already.

My first Potential Multibaggers pick was Shopify in May 2017 at a split-adjusted $7.76. In each and every year since then, Shopify's stock was down 30% or more for a while. As you know, the recent crash dwarfed all previous drops. The stock is still down 71% from its previous high.

But at the same time, it’s still more than a sixbagger too.

Of course, with a hindsight bias, you could say it would have been better to trim or sell. But usually, if you are a long-term investor, it’s better not to do that. When will you sell? The stock can go up another 200% or more. When will you buy back? The stock can drop another 50%. You can never tell. Of course, looking back it’s always easy. I have heard many seasoned investors saying: “If I only had held Netflix/Amazon/Tesla/Apple/Walmart or … (fill in more stocks yourself) and I would already have retired by now.” That 2x or 3x seemed a great victory at the time, but not years later.

I learned that lesson to a certain as well, albeit not to the same extent, with Square (now Block). I bought it at $15 and sold it at $24. Only much later did I buy it back at a much higher price.

Volatility works both ways, up and down, although a lot of people only look at volatility when a stock goes down. But you really need volatility to have outsized gainers and therefore I see volatility just as something inherent to growth investing, not something negative.

To be a great long-term investor, you should train yourself to be unmoved by stock price movements. After all, a volatile stock price doesn't mean a volatile business.

Being unmoved by stock price movements sounds easier than it is. I think most of you need no convincing there anymore after 2022. When the stock price drops, you hear all kinds of negative arguments about why that is. Some might even be true but don't let it distract you from your long-term goal.

If you selected quality, and that's what I always strive for, stocks that fall represent opportunities, not threats. Say this out loud with me:

All future stock market crashes look like threats, but all past crashes look like opportunities. Think ahead!

I have given this the layout of a quote, not because it is one (I made it myself) but because it stands out like this, and I want you to really let that lesson sink in. So say it out loud again. If your partner looks bewildered that you talk aloud to yourself, just say that you are training to make money. He or she will understand and encourage you to do it again and louder. :-)

100 baggers

If you are a true long-term investor, you should be happy if the stock of a great company drops. I know that sounds counterintuitive for most investors and some will even get angry. I'm pretty sure that many of you feel stressed when their stock drops by double digits.

Of course, it never feels good to see your portfolio's worth shrink and I am human as well, of course. You think about your hard-earned money and see it melting before your eyes. Focus on what you can add to your portfolio, not on what's already in. If you can't add for some reason, you should realize that your chances of winning haven't changed because of a drop. Your chances only go away at the moment that you sell everything.

In his excellent book 100 Baggers, Christopher Mayer shows and writes about 365 stocks that have become 100 baggers (and more) between 1962 and 2014, all stocks that turn $10,000 into $1M and more.

All of them have gone through really big drops, some of them several times. All of the 100 baggers, all 365 mentioned in the book, without one single exception, have experienced a period in which the stock had plummeted 50%. An overwhelming majority dropped more than 75% on several occasions. So be prepared for big drops from time to time and don't let them scare you out of your position.

Examples

We all know how well Amazon has done over the course of the last two decades. If you had invested $1,000 at the IPO and held all the way through, be a millionaire from that stock alone. And that’s after this big drop we have seen recently.

But this is what you have to be able to endure: since its IPO, Amazon dropped between 10% to 19% 30 times, it dropped between 20% to 29% 15 times, it dropped between 30% to 39% 8 times, it dropped between 40% to 49% 5 times, it dropped more than 50% 5 times and more than 90% 1 time (during the dotcom crash). That 90% is extreme and rare but you should realize that all the rest is perfectly normal to attain such life-changing investments. If you ignore the fact that it's normal, and you don’t prepare for it mentally, you will sell, I can guarantee that.

Netflix is another example. If you would have bought at the IPO, this would have been the result of a $1,000 investment:

Again, it was no smooth ride. This is from August 2011 to September 2012

Down 80%. I can hear the bears calling already: “You need a fivebagger just to be at break-even then!” First, this is negative cherry-picking, as you assume that everyone has bought exactly at the top, secondly a stock that drops so fast has more volatility and can go up fast as well. Of course it’s no guarantee. But this is what Amazon’s stock did in the two years after it had reached its bottom, for example.

A more recent example? Square again (now Block). After the pandemic bottom, it rallied almost 600% in less than a year. Yes, I’m very aware that it fell back quite a bit after that with the crash in growth stocks we have seen, but that’s not the point. I just want to show that after a crash the recovery can be as breathtaking as the drop.

Back to Netflix. Suppose you bought for $10K at the very top then, in August of 2011, you would still have a great result today, despite the big drop recently:

There were also several periods when the stock didn't return anything for years. From 2004 to 2008, for example. Ok, there was a crash in 2008, but still. This is from May 1, 2011 to July 1, 2013, which serves as another example:

I think that pattern is very recognizable for many investors who bought a few years ago. They are either under water or flat.

This is how just how many great growth stocks behave. Sometimes they jump ahead a bit, sometimes they stand still for a few years, testing investors’ patience, and then suddenly sprint back up. That's the positive side of volatility in action. If you have sold the stock because it went down or didn't move much, you miss a lot of the upside, of course.

If you are not patient enough and you don't have a long-term investment horizon or a strict short-term trading strategy, it could be a losing strategy to buy high-growth stocks. And because so many people, the majority of investors, don't have the patience and feel the urge to do something, it's a competitive advantage if you can zoom out and be patient.

There are a few common characteristics in the most life-altering investments in history and high volatility is one of them. You should know that and prepare yourself for that. Hey, even Berkshire, Warren Buffett’s and Charlie Munger’s investing vehicle, was down 50% several times.

I'm sure if you say it out loud a third time, your partner, children and pets won't be as shocked anymore, so here we go again:

All future stock market crashes look like threats, but all past crashes look like opportunities. Think ahead!

If you teach yourself to sit through volatility, that can be your entrance ticket to really life-changing outsized gains, your exam to pass the 'great investor' exam. 

Don't look at the stock price too much

Too many investors look too much at the stock price and the stock price alone. I get it, that’s what we are all bombarded with every day. But unless you are a trader, the information is not there, but in the quality of the management, the vision of the founder, the balance sheet, the growth numbers, the products, the interaction with customers, the options that the company has, etc.

This is the most recent graph I found, but the average holding period for stocks now is just 5.5 months.

This shows that more and more people trade and then investing for the long term can be a real competitive advantage.

Of course, the difficult aspect of long-term investing is holding on to your stocks for a very long time without losing your conviction or patience. There is so much volatility and negativity that you have to be really strong to resist throwing the towel into the ring. If you see a drop in the stock price as a huge risk, it won't be easy to have outsized gains from long-term investing.

Conclusion

Doing nothing in the middle of calamity can be a competitive advantage. You need volatility to have big gainers and if a drop scares you out of your position, you can miss the positive side of volatility, a huge surge.

Many growth investors have sold their stocks already and left the market completely, went to cash or switched to an index fund because they were scared out of their strategy. That’s taking the elevator down and staying there or taking the stairs up. I know I’m in an elevator, which goes down fast but goes up fast too. Knowing what kind of investor you are is very important and your portfolio should reflect your personality. I am emotionally not affected by the big drops we have seen because I have visualized this for years and I keep adding money to my portfolio which allows me to average down in quality stocks.

And how could we end this article better than with the most important thing to remember?

All future stock market crashes look like threats, but all past crashes look like opportunities. Think ahead!

I hope you enjoyed the article and in the meantime, keep growing!