In the long-term, most of what we thought were growth stocks end up being cyclical. When it occurs in a particular market, growth attracts competition. New competition exerts downward pressure on prices and margins. To be sustainable and resist competition, growth needs to be achieved with high margin. This can be built, over time, in consumer markets, with quality, branding and very tight execution. Typically, growth stocks have “pricing power” and moats. From an investment perspective, growth stocks are well recognized and therefore trade at very rich valuation. 

Sustainable growth stocks exist in technology, but they are hard to find. Technology is by construction unstable. Technology managers are threatened by constant innovation and new entrants. Most of the time, they focus on growth of the topline “whatever it costs”. So, when rates rise and the economy slows, technology growth stocks margins can enter very quickly in negative territory. Supposedly non-cyclical growth stocks suddenly looks very cyclical. 

It is precisely what happened last week with a few software high-fliers like Atlassian and Twilio. A slight downward revision in their guidance sent their shares plummeting more than 30% in one day. Low profitability widely accepted in a bull mood powered by free money, suddenly became unbearable. In the previous fortnight, Meta received a similar treatment despite being cheap and very profitable. In that case, the market negatively voted on the metaverse huge capex requirements and questioned Mark Zuckerberg ability to execute. 

Major profitable tech giants like Apple, Microsoft or Google also suffered in sympathy. Microsoft and Google are off roughly 40% from their 2021 high. Looking at their last results, it seems that things have not really changed. In both case, cyclical headwinds are compensated by rising cloud demand. Structurally high profitability and a strong balance sheet are offering a margin of safety.



Short-term overshooting is providing long-term investors with attractive entry points.