POV: It’s March 2020, the world seems to be falling apart due to a new virus that’s sweeping the globe. You’re working from home for the next two weeks (ha!), which means you have a lot more time on your hands to fully experience your first bear market. At least, this was my experience. I and many others watched our portfolios, which we thought could only go up, go very down very quickly. Not a fun time!
Of course the markets have recovered since, and 2021 was a great year to have been invested. But for a time, the pandemic created a fundamental shift in the types of businesses that were well-positioned to succeed. Hospitality stocks, restaurants, and airlines initially got hammered, and a new class of “pandemic stocks” emerged. Companies whose businesses were extremely well-positioned to thrive in a work-from-home world.
Of course in my panic, I made no money moves that would have exposed me to these great companies. But now I’m two years older, my skin is a bit tougher from my first adult recession, and I’m left wondering, “what could have happened if I’d been able to see the trends and make the right buys?” Let’s indulge the what-ifs for a moment.
Of course, everything that follows is not financial advice. Please do your own research before smashing that buy button.
I love this chart for its perspective. What we’re looking at is the change in value of 3 popular pandemic stocks (Peloton, Zoom, and Teledoc) relative to the S&P 500. We’re looking for performance delta, so each line on this chart represents the percent change of the stock relative to Feb 1, 2020, minus the percent change of the S&P 500 (hence why the S&P appears flat here).
At one point in October, ZM was outperforming the S&P by 543%. PTON, at its peak, was outperforming the index by 378%, and TDOC was up 168%. These are serious numbers! If we’d invested $1000 in each of these companies on Feb 3, 2020 and sold at their highs, we would have turned that $3k into more than $14k, and beat the S&P 500 by nearly 400% while doing it! Isn’t that fun? But alas, timing the market is impossible, but if anyone out there managed to do that, big ups to you - please start a hedge fund so I can invest in it.
Eventually, things revert to the mean
What’s more interesting are today’s numbers. As of this writing (March 20, 2022), all three of these stocks are now underperforming the S&P. ZM by just a little, and the other two by a lot. If I’d invested that same $3000 in those same stocks and held them until today, I’d have lost $200, and underperformed the S&P by 42%! However, by the time you read this, things may have changed! You can mouse over the chart above to see the latest data.
These trend stocks would have made for outsized returns had you been able to time the market even reasonably well, but what’s the mental and emotional cost of riding the roller coaster? Unless you have the stomach for the thrill ride of individual stocks, it can be draining to be constantly refreshing your brokerage to see where you’re at.
An oft-used measure to gauge the volatility of a stock is its standard deviation. For those uninitiated in the world of statistics, standard deviation is essentially a normalized view of the differences in a set of data points. Higher numbers mean more volatility, lower numbers mean less volatility.
As you can see in the chart above, every stock in our small list experienced a little volatility. Even the S&P experienced a period of relatively high volatility between March and April of 2020. But you can see that ZM and TDOC experienced significantly elevated volatility over the duration of the period, with PTON looking a little bit more like the S&P with the exception of a few spiky periods.
How much should we get paid for the risks we take?
How do we achieve returns that don’t turn our hair gray? I suggest looking at a metric I like to call return on volatility, which we can define as the ratio of absolute returns to standard deviation. Let’s look at the return on volatility for each of these stocks.
This chart shows the dollar return on a share of our pandemic stocks for every dollar of standard deviation at that point. It’s not a perfect metric, but it shows that even as soon as April 2021, the S&P started showing outsized resilience on a dollar/risk ratio.
As investors, it’s up to each of us to decide how much risk we’re willing to tolerate. There is so much upside potential in the markets, and almost always, the biggest profits (and the biggest losses) go to those who are willing to take the biggest risks. For me personally, I’m willing to accept potentially lower returns for the peace of mind of more stable investments in the bulk of my portfolio. Of course, I still allocate some percentage of my portfolio to industry bets, like green energy or robotics, but for the most part I like to ride along with the market. I simply don’t have the stomach for the big losses that come along with highly volatile stocks and ETFs.
Often, as we saw above, volatile stocks will eventually revert to the mean. One has to time the market extremely well in order to extract maximum value.
Let’s look at one more example, ARKK vs BRK.A. The chart below displays the returns over the same period of Cathie Wood’s ARK Innovation ETF (mostly emerging tech stocks) vs the Class A shares of Berkshire Hathaway, which invests mostly in stable blue chips.
Tech stocks have had a rough go of it lately, and I’m personally bullish on tech in the long run, but again it’s interesting to view these through a lens of optimizing for returns on volatility. The data show that ARKK had periods of significant upside, but with a lot of volatility. BRK.A on the other hand, has been giving slow and steady returns over the last year. Now, they’re basically in the same place.
Looking at the return on volatility for the same stocks in the same period, you can see that, for a while, you couldn’t beat ARKK’s return on volatility. Since around Feb 2021, however, both the S&P and BRK.A have offered higher returns on a volatility basis than ARKK.
Return on volatility is not a perfect metric, but it can offer interesting insights into how much performance you’re really getting in exchange for the ups and downs of a stock you own. Of course, it’s up to you to decide what your own tolerance for risk is and how much volatility you’re willing to handle as an investor.
Try it out for yourself
Calculating Return on Volatility is easy! We built Factor.fyi to easily build and visualize data that you can’t see anywhere else. Give it a whirl by:
- Finding the return on volatility for your favorite stock.
- See the S&P Stocks with the widest 52-week ranges.
- See where popular cryptocurrencies are relative to their all-time highs.
- Create a new question all of your own.
Factor.fyi is an open BI platform to query, browse and share financial and macro data.