Buy and Hold Strategy

Buy and hold is a timing strategy, which uses the same concepts as the time value of money. If you own a company that is growing, it will be worth more in the future then it is today. It reduces the problem of constantly timing the market’s ups and downs and keeps trading costs to a minimum. Inflation risks are automatically hedged. Over time, companies naturally pass on cost increases to their customers, resulting in higher EPS and therefore higher stock prices to counter the negative effects of inflation. Buy and hold, however, does not eliminate the issue of knowing when to buy and when to sell. When executing a long-term strategy, investors need to really understand their core being. Buy and hold investors, in particular, need to understand themselves, to ensure their long-term strategy matches their financial and risk objectives, as well as, their personality. Holding a stock requires strong discipline and belief in oneself. Being afraid to trade a security or holding a stock for sentimental reasons may not be a valid or profitable investment approach.

For an investor to make money in the stock market, there are only a few decisions that have to be made correctly. The first is the company they buy and the price they pay. A friend of mine bought Genentech on the first day of trading; great company wrong price. She held it almost twenty years, maybe she tripled her money. The moral is you need to buy low. If one grossly overpays for a security, holding it forever won’t cure their initial mistake.

Additionally, the stock needs to be conducive to a buy and hold strategy.

For example, utilities, consumer products, food, defense, oil and banks are the types of industries that have recurring customers and products that take to the buy and hold style. While these companies normally won’t produce “the big win,” they should provide an above average steady return, without the risk of losing it all if a “better mousetrap” is built by a competitor. Procter and Gamble is the classic example of a buy and hold company. Companies that constantly have to invent new products to keep up with changing demand and have stiff competition, along with a short product life cycle, are not buy and hold type companies. For example, technology companies always need to invent new products. These are not buy and hold type companies.

When a company has to continually develop new products and sell them to new customers, it’s hard. Eventually, the grind gets to them. What about companies like IBM? They are the exception. Many people forgot about Burroughs, Sperry, NCR, Digital and Wang. Drug companies were for decades the classic buy and hold stocks. Now, however, competition is extreme, and they cannot create new drugs fast enough to replace the lost revenues from compounds coming off patent protection. R&D issues, together with socialized healthcare on the horizon, caused these companies to lose their buy and hold appeal and some are even considered risky investments.

Many people have the wrong view of what buying and holding represents. Some feel that they could buy a stock and forget about it for 40 years. I don’t know where this philosophy ever came from; it’s wrong and it’s foolhardy if you practice it! Holding a security doesn’t mean you stop thinking after you purchase it. Making money in the stock market is a job. Once you buy a security, you have to follow it and monitor its performance. Investors should read the company’s annual report or SEC form 10-k and quarterly reports and even the 8-k’s. The 8-k’s are material events that require fast disclosure to the SEC. If the company changes its management or business model, you need to re-evaluate if the changed company is still what you want. Investors should also watch the stock price. There is no need, however, to track stock prices daily on the internet, but you should read your monthly or quarterly broker’s statements. If you bought a great company and its stock price went way up, maybe even discounting the next 10 years of growth, you need to sell. Selling is a natural part of owning a security. When the stock’s expectation greatly exceeds reality it’s time to sell. Coca-Cola is a great company; back in 1998, when it sold at a 62 P/E ratio, it was time to sell and wait for its growth to catch up to it’s price. Even a buy and hold style requires monitoring your investments. Remember the game is to make money, not to own stocks for the stake of owning stocks.

An easy way to compound your return on a buy and hold stock is to reinvest the dividends.

Buy and hold is a time tested and proven strategy that has historically worked, and still does. A stock, however, must be conducive to a buy and hold strategy, the company needs to be periodically monitored, and the long-term (5 years to a decade or two) strategy must fit the personality and goals of the investor.