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#MoneyBeat Can Big Tech Stocks Grow Without Limits?

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The more flippant the investing cliché, the more you should question it. Consider “the bigger they are, the harder they fall.”

At their lows this week, the technology shares that have until recently been the stock market’s darlingsFacebook, Amazon.com, Netflix, Google’s parent company Alphabet and other giants — had fallen more than 17% since March 13. Over the same period, U.S. stocks overall fell 8%.

At first, the drop in big tech stocks seems driven by bad news that is bound to worsen: Facebook improperly sharing personal data, President Trump criticizing Amazon, European regulators investigating potential antitrust violations.

Or could this just be a stumble? Have big tech companies developed an unstoppable business model?

The idea might not be quite as crazy as it sounds. Charlie Munger, Warren Buffett’s business partner, rarely shows much mercy toward investing beliefs he regards as foolish. But when he was asked at the February annual meeting for shareholders in his Daily Journal whether Google, Facebook, Apple and Amazon are overvalued, Mr. Munger said, “I don’t know. Next question.”

Traditionally, the bigger companies have gotten, the harder it has become for them to keep growing at the same rate. For today’s leading innovators, however, growing might not have to mean slowing. Unfettered by the costs of raw materials or the burdens of manufacturing, distribution and advertising, these companies plan decades ahead, rather than fixate on hitting Wall Street’s quarterly earnings targets.

Consider Amazon. Over the three years ending Dec. 31, 2011, its revenues more than doubled, to $48 billion. Over the next three years, its sales nearly doubled again, to $89 billion. Then, over the three years ending Dec. 31, 2017, Amazon’s revenues doubled yet again, to $178 billion.

Investors don’t know exactly how to price such rapid growth. Although the cash Amazon generated from operations grew more than tenfold from 2008 through 2017, the company plowed most of it back into expanding the business. So net income grew only less than fivefold, with enormous fluctuations along the way.

James Anderson, head of global equities at Baillie Gifford & Co. in Edinburgh, thinks Amazon, along with some other giants including Chinese firms Alibaba Group Holding and Tencent Holdings, “live in a permanent state of revolution.” They have “a profound distrust of the idea that scale has to impinge on a business’s ability to grow and keep disrupting.”

Baillie Gifford, with $290 billion in assets, had a total of more than $22 billion in Amazon, Alibaba and Tencent as of year-end 2017.

“A small set of superior companies drive returns in the long run,” says Mr. Anderson, citing research by finance professor Hendrik Bessembinder of Arizona State University. That study shows that the stock market’s entire return over time has come from fewer than 4% of all stocks.

Of course, history also suggests that every firm that was expected to dominate indefinitely — from RCA in the 1920s to IBM in the 1980s to Nokia in the 1990s — has ended up slipping.

And the idea of virtually limitless growth flies in the face of much of human experience. Trees can’t grow to the sky because they would be bent and crushed under their own weight first.

As the epigraph for his 1934 book “Security Analysis,” the fundamental text for evaluating stocks and bonds, the great investor Benjamin Graham chose these words from the Latin poet Horace: “Many shall be restored that now are fallen and many shall fall that now are in honor.”

The twin beliefs that high-fliers must fall to earth and that underappreciated stocks should rise again are at the heart of value investing. It’s conceivable that those principles may be less relevant today, when powerful technology companies can pulverize entire industries.

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Nevertheless, as companies grow, “the more scale you have, the less nimble you become,” says John Linehan, portfolio manager of the $22 billion T. Rowe Price Equity Income Fund. Despite all the recent growth of the tech giants, he says, “I don’t think that’s changed.”

In a classic article, “Growth Stocks and the St. Petersburg Paradox,” finance scholar David Durand warned that at ultra-high growth rates over long horizons, even slight shortfalls lead to enormous differences in end results. That makes the shares of such companies extraordinarily volatile.

With Amazon and Netflix trading at more than 200 times their net profits, and many of the other new tech giants at more than 40 times earnings, they aren’t exempt from that iron law.

It’s impossible to know for sure whether companies like Amazon have broken free from the traditional limits to growth. Unless you can hold them for a decade or more, as Mr. Anderson likes to, you probably will get shaken out before you can even find out.

Write to Jason Zweig at intelligentinvestor@wsj.com, and follow him on Twitter at @jasonzweigwsj.

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