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Buy and Hold Still Works - Only with Dividends
Posted by: Mark Lin (IP Logged)
Date: December 6, 2012 10:07AM

The concept of “buy and hold” (possibly forever) has been an item of contention among value investors today.

The theory of “buy and hold” is premised on two major assumptions.

First, the company is a great company and continues to be great — there are no major changes in the value drivers and prospects of the company for the foreseeable future. Second, the investor bought the stock at an attractive discount to its intrinsic valuation (or “margin of safety” as Benjamin Graham would call it).

The biggest weakness of the buy and hold theory is that there is no explicit mention of exit — return of capital and upside beyond that to investors. Equity research analysts like to use the concept of a catalyst as a solution to this problem. They frequently identify catalysts in their writing, calling out for events that drive stock price towards their intrinsic value, as part of their analyses. I am a non-believer, when it comes to the idea of a catalyst. In my opinion, undervaluation itself is the best catalyst.

So, what is the right strategy? Combining the idea of buy and hold and dividend investing makes more intuitive sense. An investor buys a consistent dividend paying stock and holds it for a period of time to receive dividend income. Once the dividend investor has recovered his capital (or at least a substantial part of it) through dividend income (it could take many years depending on the dividend yield), he could then choose to either to continue to hold the stock to receive dividends or sell the stock for capital gains.

On the other hand, buying and holding a non-dividend paying stock for it to reach its “intrinsic valuation” could be a long fruitless wait, perpetuated by the fact that there are no dividends in between to tide the investor through. In the worst case scenario, the stock never reaches its “intrinsic” valuation or anywhere near, commonly referred to as a "value trap."

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Re Buy and Hold Still Works - Only with Dividends
Posted by: batbeer2 (IP Logged)
Date: December 6, 2012 01:12PM

>> In the worst case scenario, the stock never reaches its “intrinsic” valuation or anywhere near, commonly referred to as a "value trap."

Hi Mark, thanks for an article worth reading.

I own some shares of DJCO. I wrote about it here.

I hope that stock never catches up with its intrinsic value. I don't think of it as a value trap and I don't want the dividends. If IV grows at 30% for many years, does it matter if the discount persists?

The reason I don't want the dividends is because Charles Munger is better at picking stocks than I am.

I get the cash and what would I do? I would go buy a stock. That stock would turn out to be an inferior investment compared to the stock Munger would have bought had he retained the cash.

Having said that, it's an exeptional case.

In short, what you wrote makes sense for a lot of stocks but there are exceptions.

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Re Buy and Hold Still Works - Only with Dividends
Posted by: marklin (IP Logged)
Date: December 7, 2012 02:39AM

Hi Batbeer2,

thanks for your insights.

You touched on two important issues here: (1) growing intrinsic value and (2) reinvestment risk.

If I am as smart as Munger & Buffett and get a few compounding machines with repeatable moats correct, the discount to intrinsic value does not matter as long as the intrinsic value continues to grow. In most cases, dividends make the pain of waiting more bearable and more importantly mitigates the catastrophic impact of capital losses with dividend income.

Reinvestment risk is also a very valid concern. In a low interest inflationary environment, cash becomes a big problem. I am actually neutral on dividend versus share repurchases. But I put a lot of emphasis on having at least one of these capital return policies.

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