GuruFocus Premium Membership

Serving Intelligent Investors since 2004. Only 96 cents a day.

Free Trial

Free 7-day Trial
All Articles and Columns »

Buy and Hold Is Dead! BRK.A, BRK.B, KO

August 15, 2011 | About:
To most investors, it seemed to be one of the 18 basic laws in the universe — ranking right up there with Kepler’s law of planetary motion and Newton’s law of universal gravitation. If an investor bought stocks and held them for the long run, there was no chance of losing money. Charts and tables were presented by financial professionals to clients, showing them that the chances of losing money in stocks, if held for 10-year periods, were about as probable as the sun rising in the West.

Perhaps they didn’t realize it at the time, but when investors took their retirement accounts and bought stock index funds, they were making two assumptions: (1) valuations didn’t matter, and (2) time would make whole all loses.

Buy and hold investors had a rude awakening at the end of 2008. A $1,000 investment made in the S&P 500 on Jan. 1, 1999, and held until Dec. 31, 2008, was worth $860, for a loss of 14%. How could that be possible? These investors did everything right and still lost money. Weren’t they just following the advice of Warren Buffett, who said that his favorite hold time was “forever?”

As with most things in life, things are not always as they appear.

Instead of buying and holding, investors should’ve been following what great investors were doing all long: buy (cheaply) and hold (until overvalued). Buying stocks regardless of valuation is a recipe for disaster. During the height of the dot-com bubble, valuations reached levels that could not be justified even by the most optimistic of investors.

101927_1313448324S39Z.png

By the end of 1999, the S&P 500 was trading at a P/E of 44 – an all-time high. Apparently investors who were taking a buy (at any price) and hold approach weren’t focused on the ridiculous valuations they were paying for stocks.

101927_13134483424442.png

When buy and hold made the most sense, such as during the spring of 1982, when stocks were trading at single-digit P/Es, investors avoided stocks like the plague.

The time to buy anything is when you are getting more value than what you are paying. The buy and hold blind spot that investors missed — not being concerned with valuations — proved tragic for many retirees.

Another way

I, too, like to buy stocks and hold them forever, but only if I can buy them cheaply and they never get to levels where their valuations make no sense in relation to the underlying worth of the business.

Warren Buffett’s Berkshire Hathaway (BRK.A)(BRK.B) has owned Coca-Cola (KO) shares since 1988 — more than two decades. In his shareholder letter in 1996, he labeled Coca-Cola one of his “Inevitables”…“companies that will dominate their fields worldwide for an investment lifetime.”

Buffett warned,

“You can, of course, pay too much for even the best of businesses. The overpayment risk surfaces periodically and, in our opinion, may now be quite high for the purchasers of virtually all stocks, The Inevitables included.

Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid.”

The market continued to head higher, and by 1999, Coca-Cola was selling at a P/E in the 40-50 range. Based on the sky-high valuation, it would take close to a decade for the market value of the company to catch up with the stock price. With hindsight, Buffett admitted that his failure to sell Coca-Cola and several other stocks in his portfolio was a mistake.

Investors who bought and held without any regard to valuation would not have fared very well. On July 14, 1998, Coca-Cola closed at $66.13 (dividend-adjusted price). It didn’t trade above $66.74 a share until April 1, 2011 — 13 years later!

Conclusion

The next time you hear anyone talk about a “buy and hold” strategy, you need to immediately think in terms of buy cheaply and hold until overvalued. If you don’t, you run the risk of buying stocks at very high valuations.

Investors who bought Coca-Cola stock at the 1998 high got lucky — they had to wait only 13 years to break even. Investors who bought stocks in companies at even higher valuations are still waiting to break even. Make sure you’re never in that camp, by making purchases only when you get more vale than what you’re paying.

About the author:

Charles Mizrahi
Charles Mizrahi is editor and publisher of Hidden Values Alert newsletter, which focuses on finding stocks trading significantly lower than their underlying business value. He has over 30 years experience in the financial world as a money manager and investor.

Visit Charles Mizrahi's Website


Rating: 4.1/5 (37 votes)

Comments

superguru
Superguru - 3 years ago
Yes, last decade taught us this lesson.

Buying stocks regardless of valuation is a recipe for disaster.

Holding stocks regardless of valuation is a recipe for disaster.
tonyg34
Tonyg34 - 3 years ago
so the buy and hold strategy also implies that you are making an annual $4,000 (or whatever you can afford) contribute to your IRA. Rather than trying to time the market you simply make your annual contribution to a balanced index fund and reinvest dividends (I'm not 100% sold on the target fund glide path theory). Over long holding periods this method has results in the top quartile versus actively manager funds, i.e. after management fees and taxes you outperform most market participants.

If you always sell at near term tops and buy at near term bottoms you will of course completely crush any other method for investing. Only problem is that no one has ever been able to articulate a system for reliably timing the market. A core balanced index approach is the smartest option for the overwhelming majority of investors. You can then explore other investment options pending your understanding of investing and tolerance for risk.

There have been multiple studies, including Jeremy Seigel's Stocks for the Long Run, that demonstrate that had you bought the S&P500 on black tuesday and held for 20 years you still would have produced inflation beating returns. Time in the market is still more valuable than timing the market.
augustabound
Augustabound - 3 years ago


There have been multiple studies, including Jeremy Seigel's Stocks for the Long Run, that demonstrate that had you bought the S&P500 on black tuesday and held for 20 years you still would have produced inflation beating returns. Time in the market is still more valuable than timing the market.

That's the problem with studies like that of Jeremy Seigel. His theory lies on the premise that you bought, or should have bought on black Tuesday.

It's unreasonable to think that success in the market relies on making your buys on one day in the market and even more so, having the intelligence or nerve to buy on the worst day in decades.

It's just like the buy and hold bears using one time frame to say the theory is dead, you can't use one point in time only to kill a theory, it requires multiple time frames.
rgarga
Rgarga - 3 years ago
[u][/u]

To all those who know more, I Completely disagree on this matter. I agree it seems that we should abandon ship. Look at the period from 1965 to 1982 when the PE contracted, but then 1982 to 1999 when PE expanded. Those who abandoned ship in 1978-1979 regret bigtime. I agree PE will likely contract over the next three to four years but you have great companies at PE of 7-8 (or 6-7 for normalized PE). I would love to say that these companies would get cheaper and would love to have that opportunity. But at some point, in our lifetime, the value will be realized. I think of it like a wonder idea. People often ignore it and then slowly and suddenly realize its worth... !!! You dont know when and how. I agree these dips are painful and will have a few more in the next few years, but this is when buy and hold takes over when you want to abandon ship! That is why us buy and hold types come and buy forever.

BTW can anyone predict S and P 500 at end of this month, end of this year and end of next year. Give me your best guess and see where we will end up being. I predict that in 2045, sp 500 would be 10000 give or take 2000. And that is no misprint. What says you?
Margin of Safety
Margin of Safety - 3 years ago


Great article, it would be interesting to measure average length of holding time for the top Gurus and how hold-times have changed over the last decade.
noblepaladin
Noblepaladin - 3 years ago
One key point is diversification over assets. Primarily, that is your stock and bond allocation. People obsess too much over stocks. If you simply dollar cost averaged into an index fund and a bond fund (I'm just doing the SP500 and PIMCO's Total Return in my 401k as I don't have the option of manually selecting securities) and rebalance once a quarter, you would have done well over the last decade because of the massive bull market in bonds. If you decide to be somewhat active and add some intelligence into your portfolio, you would underweight equities when they are clearly overvalued (P/E of 20+, looking at GMO's asset forecasts, using total market cap to GDP, etc).

You should be up even if you started dollar cost averaging and rebalancing starting at the height of the tech bubble.
LwC
LwC - 3 years ago
"That's the problem with studies like that of Jeremy Seigel. His theory lies on the premise that you bought, or should have bought on black Tuesday. "

Well IMO that's not actually correct. Seigel may have used that as an example to illustrate a point, but in fact his research is much deeper and broader than that. Seigel's research includes numerous categories of investment time horizons, including moving 5 year periods, moving ten year periods, moving 20 periods, etc., and also other methodologies of analysis. AFAIK no one has actually refuted his research, although many people have expressed opinions about it.

IMO that particular comment about buying on Black Tuesday and holding for 20 years would have produced inflation beating returns illustrates at least two points: that an investor makes his return when he/she buys, by not paying too much; and that an investor could have beat inflation on average over those 20 years in spite of the disaster of the so called "lost decade". That's interesting to me because my first goal (after avoiding a loss of capital to an investment of course) is to earn a return that meets or beats the cost of inflation on an after tax basis over the period that the investment is held.

Of course theory and practice are two different things…

Good luck.

AlbertaSunwapta
AlbertaSunwapta - 3 years ago
Mr. Mizrahi, as Buffett says, its better to be approximately right than precisely wrong and the reality of most peoples savings makes "all in" buy and hold investing very unlikely. Most people invest over time as their incomes allow it.

As such you're being selective in your choice of time periods (the 10 years from Jan 1, 1999) and somewhat comparing apples to oranges by making the mistake of using aggregated (index) returns to generalize the market trend and then cherry picking individual stocks to support your case. There will be many examples of successful buy and hold stock picks over that time span. I'd expect oil companies showed positive returns. It's just that the odds of a decline over that period sided with the indexes direction.

Few sane people move 100% of their portfolios into either an single index or a single stock in a single trading session. Take Japan. Few if any investors, except those with perfectly bad timing, are down 75% plus on their invested capital over the past 20 plus years. Many would have invested years prior to the peak. Many would also have continued to invest during the decline. Still, Japan, or more specifically the Nikkei is the poster child for the reality of buy and hold investing risk. It may also become the poster child of buy an hold investment gains should it return to and exceed its prior peak. Did you go all in, on the day it bottomed?

Moreover your prescription to "Buy cheaply and hold until overvalued", contains the similar flaws in logic as does the "Buy and Hold" rationale. Buy how cheaply? Sell when overvalued by how much? Remember, at the time Buffett said he'd sell Coke "without blinking an eye" if it hit something like a P/E of 65. It didn't and so he didn't. Intrinsic value and commensurately, overvalued-ness, is a moving target involving a lot of assumptions, so again, one's judgement of the degree of overvalued-ness means that one can only be approximately right. Selling at too low a level of overvaluedness, and paying taxes on the gains could lower your eventual returns should that company or index be a long term grower. So just because the market hasn't seen fit to raise the price of KO over the past decade, that doesn't mean it couldn't have happened, thus raising the buy-back cost of taking the 1999 gains. The day trader's conundrum can be the decade trader's conundrum if you have a multi-decade horizon.
Sivaram
Sivaram - 3 years ago


Rgarga: " I agree PE will likely contract over the next three to four years but you have great companies at PE of 7-8 (or 6-7 for normalized PE). I would love to say that these companies would get cheaper and would love to have that opportunity. But at some point, in our lifetime, the value will be realized."

I agree with the view in your post but I think you have to be careful with the low P/Es. Even though P/Es look low for some companies, do keep in mind that profit margins are near multi-decade high. Because of that, although I'm a big fan of P/E to judge market valuation, I think the market isn't as cheap as it seems. For instance, if you look at price-to-sales or price-to-book ratios, the market isn't as cheap as it seems.
Sivaram
Sivaram - 3 years ago
Dhennessey1: "Great article, it would be interesting to measure average length of holding time for the top Gurus and how hold-times have changed over the last decade."

I don't know about the so-called gurus but the hold period for investors as a whole declined to an all-time low earlier this decade (not sure about the last few years). I wrote a post with a graph showing the average NYSE holding period from 1940 to 2005 if you are interested. The average holding period for all investors (at least for NYSE data) from 1940 to 1970 used to be around 7 years. In 2005, the average holding period declined to 1 year!!! My guess is that the present holding period is probably between 1 and 2 years (just a wild guess). The short holding, I suspect, is mainly due to the emergence of quant funds--a huge chunk of a the daily trade is due to quant funds, who hold positions for as short a period as 5 seconds--and the popularity of momentum investing.

So, the average holding period has actually been extremely low this decade. This is why I always find it funny when people talk about buy & hold being dead; well, hardly anyone is buying & holding so I'm not sure how something that isn't even popular is dead all of a sudden. If anything, buy & hold is going to become popular again. People who are holding stocks for 1 or 2 years is going to start holding them for 5 or 6 years in the future.

Please leave your comment:


Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK