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.
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.
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.
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 (NYSE:BRK.A)(NYSE:BRK.B) has owned Coca-Cola (NYSE: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.”
“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!
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.