"Why Buy and Hold is an Inferior Strategy"

[mikazo]

Some on this board might consider it sacrilegious to watch videos on trading and speculation (gasp!), but I've found the YouTube channel of Tastytrade to be very informative for me in trying to learn about options (which I can then apply to investing in LEAPs, etc.).

 

Anyway, they posted a video today that I found interesting and actually relevant to some discussion that has been going on on the board recently. As the market has been pushing new highs, members have been discussing trimming various long positions. It occurred to me that this wasn't in true Buffett style to not buy-and-hold-until-you're-dead.

 

The following Tastytrade video compares buying near market lows and selling near market tops to simply buying near market lows and holding forever:

 

I haven't checked their math, but I'm curious if what they claim in the video only works for the specific time period they chose, or can be generalized across the history of the stock market.

 

In any case, I thought it would be interesting to watch and discuss, even though we're value investors and the guys in the video are not.

[rranjan]

Some on this board might consider it sacrilegious to watch videos on trading and speculation (gasp!), but I've found the YouTube channel of Tastytrade to be very informative for me in trying to learn about options (which I can then apply to investing in LEAPs, etc.).

 

Anyway, they posted a video today that I found interesting and actually relevant to some discussion that has been going on on the board recently. As the market has been pushing new highs, members have been discussing trimming various long positions. It occurred to me that this wasn't in true Buffett style to not buy-and-hold-until-you're-dead.

 

The following Tastytrade video compares buying near market lows and selling near market tops to simply buying near market lows and holding forever:

 

I haven't checked their math, but I'm curious if what they claim in the video only works for the specific time period they chose, or can be generalized across the history of the stock market.

 

In any case, I thought it would be interesting to watch and discuss, even though we're value investors and the guys in the video are not.

 

I am not really buy and hold forever but I think it's difficult for anyone to consistently know the market lows/highs in advance.

[Parsad]

The rule should really be:

 

"Buy and CAN hold for the LONG-TERM!"

 

Meaning, you buy businesses that you can hold for long periods of time at an excellent discount to intrinsic value.  That way you can hold the investment until the markets arbitrage the difference.  And/or continue to hold if intrinsic value continues to grow at an adequate rate.  Cheers!

[Uccmal]

I Believe the title of the board is Corner of Berkshire and Fairfax. 

 

FFH rarely sticks to a permanent buy and hold strategy. 

 

There is Buffett for the masses, and Buffett for the more sophisticated investors.  Buffett for the masses works for the masses.  Buy and hold WFC, Berk, And KO.  It keeps the masses from losing money. 

 

Buffett's strategies dont vary much from what we mostly discuss here.  Up until the late 1990s he was still a buy until a good price was offered for my stock (GD)  or I realize I goofed (US Air, Solomon).  Outside of wholly owned entities he has invested in hundreds of common stocks, and held a handful more than a few years. 

 

Do what I say, not what I do. 

[DTEJD1997]

Unless you have a private company like See's, I think buy and hold "forever" is a huge mistake.

 

Buffet made a HUGE mistake with Coke.  I think it was in 2000 it was something like $70 a share.  I think in the year 2013, KO is just about at the same price.

 

Think of all the bargains Buffet could have picked up in tech crash, or the crash in 2008, or heck, even buying KO back a few years later for 1/2 the price.

 

I've personally seen people buy stock (housing builders) in the mid 90's see them go up 25X, 50X or even more, and then lose a TON in the housing crash.

 

Unfortunately, the highest return I've had yet is only about 4x.  However, if I got a huge gainer, like 10x or more, I think I would either sell covered calls, OR maybe have a trailing stop.  Trees don't grow to the sky, and neither do stocks.

 

Things also change over long periods of time.  Heck, look at GM in the late 50's, and then look at GM in the late 70's.

 

I think a long holding period is GREAT, but don't get married to your stock!

[sethatk]

Buffet making more in dividends on Coke than his initial investment.

[Shane]

so?

[MrB]

On the one hand you can buy a $1 stock at 50 cents, while management is buying out your partners aggressively and sell at $1 or more 5 minutes later or 5 years later depending on the mood swings of the market.

On the other you can throw darts at a list of stocks and trade accordingly.

 

It is possible to produce satisfactory returns between those extremes, but the probability of success scale from very high to very low.

 

Choose the probability that you are comfortable with. Good luck and I look forward to meet you in the markets.

 

P.S. I just finished the Shipping Man due to the rec on this board. Although I hated about every minute I spent reading it, afterwards I thought to myself; I earn a living off guys like that. More power to them!! ;D

[jay21]

Unless you have a private company like See's, I think buy and hold "forever" is a huge mistake.

 

Buffet made a HUGE mistake with Coke.  I think it was in 2000 it was something like $70 a share.  I think in the year 2013, KO is just about at the same price.

 

Think of all the bargains Buffet could have picked up in tech crash, or the crash in 2008, or heck, even buying KO back a few years later for 1/2 the price.

 

 

I think they were non-financial reasons for him not selling such as his involvement with management and the board. 

[jtvalue]

Let me preface this by saying I'm as big of a Buffett admirer as anybody.  However, I think buy and hold is a bad idea if you know what you are doing, like most of the people on this board.  In the 1998 annual report Buffett's equity portfolio looked like this:

 

36% KO

14% AXP

12% Gillette

10.4% Freddie Mac

6.8% WFC

2.7% Washington Post

18% Other

 

And here are the subsequent 15-year annualized returns for these stocks and the S&P 500 per Morningstar:

 

S&P 500: +4.59%

 

KO: +1.79%

AXP: 6.86%

Gillette (I'm using PG which I know isn't 100% accurate): +5.86%

Freddie Mac: -98% since 1998

WFC: +6.5%

WPO: +0.4%

 

BRK.A: +5.87%

 

Now would anybody on this board be happy having 36% of their portfolio in a stock with a 1.79% annualized return over 15 years?  Or have their best performing position be 6.86% over 15 years?  I completely understand why Buffett buy and holds (Berkshire culture, taxes, friendly acquirer), but it doesn't mean that its right for everybody. 

 

[alwaysinvert]

The rule should really be:

 

"Buy and CAN hold for the LONG-TERM!"

 

Meaning, you buy businesses that you can hold for long periods of time at an excellent discount to intrinsic value.  That way you can hold the investment until the markets arbitrage the difference.  And/or continue to hold if intrinsic value continues to grow at an adequate rate.  Cheers!

Thread should have been done here. Favorite holding period forever only means that 1) turnover only when necessary/beneficial 2) companies should be able to stand the long-term. It's a mental model/checklist item for BUYING and not some kind of life rule, as evidenced by Buffett's own portfolio turnover.

[merkhet]

jtvalue, did you take into consideration dividends for KO?

[Palantir]

 

Buffet made a HUGE mistake with Coke.  I think it was in 2000 it was something like $70 a share.  I think in the year 2013, KO is just about at the same price.

 

After you account for his epic capital gains taxes? Then invest that cash into a sector he knows little about?

 

Personally, I believe in the long term buy and hold to an extent few value investors do. I don't follow quarterly earnings, don't bother listening to conference calls, frankly after I buy stock in a company I pretty much stop following it because I believe in it and want to hold it for years, so I don't really care what the next earnings report says. Mostly because I am too lazy to do more work than I need to  ;D. Let's see how it goes.

[bookie71]

Did you factor in the tax hit if he sold coke?  What  were disclosure rules as I believe he was on the board?

[rukawa]

Buffett wasn't buy and hold until the later part of his career. I think buy and hold makes total sense if you are managing a 100 billion dollar portfolio because at that point it takes a while to accumulate large positions in stocks and its also extremely difficult to outperform. Trading costs also become a huge issue.

 

BTW, I think Buffett was well aware that it was an opportune time to sell KO in the late 1990's. Not all his decisions are based purely on returns.

[Mephistopheles]

If I remember correctly, he later admitted that it was a mistake not to sell KO in the late 90s.

[value-is-what-you-get]

It looks like we are talking about two different things here.  Buy and hold as outlined in the video is inferior to market timing because they are essentially wagering on price changes.  Betting slips, not partial ownership in quality companies. 

 

I do not see what is wrong with receiving an annual dividend (highly likely to increase) of 30+% on a split-adjusted cost basis on a stock which is worth 12 times what you paid for it.  Due to the moat of the business this trend is likely to continue for the foreseeable future.

 

It was one of Berkowitz's points about BAC at $7 or so - holding it over time is likely to produce a double digit dividend income in perpetuity when buying at that price - price appreciation is a bonus.

 

 

 

[constructive]

If I remember correctly, he later admitted that it was a mistake not to sell KO in the late 90s.

 

"Nevertheless, I can properly be criticized for merely clucking about nose-bleed valuations during the Bubble rather than acting on my views. Though I said at the time that certain of the stocks we held were priced ahead of themselves, I underestimated just how severe the overvaluation was. I talked when I should have walked."

2004 Annual Letter

 

http://www.google.com/url?sa=t&rct=j&q=&esrc=s&frm=1&source=web&cd=12&ved=0CDAQFjABOAo&url=http%3A%2F%2Fwww.latrobefinancialmanagement.com%2FResearch%2FIndividuals%2FBuffet%2520Warren%2FThe%2520Waiting%2520Game.pdf&ei=fT2eUb7hDOv_4AOt-4DwAg&usg=AFQjCNGLX390XLI-Hg08b_jD4CxKYoQugg&sig2=WxS1nPyJ_sOieBTPJgYekw

 

"But Buffett says he erred by not selling them at their late 1990s peaks. Coke, at 45, and Gillette, at 30, are about 50% below their highs. "Coke and Gillette weren't the focal point of the bubble, but they achieved bubble prices," the Berkshire chief observes.

 

At their highs, Coke and Gillette traded for about 50 times earnings. Buffett said his role as a Coke and Gillette director would have made it nearly impossible for Berkshire to sell its stakes several years ago. As a director, Buffett might have been deemed to be in possession of insider information."

[Cardboard]

Buffett makes money in large part by being leveraged and that has been going on for over 20 years now. His leverage costs him very little since it is insurance float that earns a little bit and borrowings done at very attractive rates. He is also making money by buying entire companies at low to fair prices with cash or sometimes using relatively expensive new shares.

 

If you look at the return on capital from his investments (Coke, Gillette and most others), you will be very disappointed and will think that buy and hold is a loser strategy. I believe indeed that it is unless you are in his situation managing 10's of billions and able to access capital for next to nothing. IMO, his investments are made more with the idea of earning a safe spread overtime than killing it in terms of returns like most of us are trying to do on this board. Like a bank if you will, but with a larger spread required and less risk than you would encounter normally for such differential. That is why he puts so much weight on being able to envision the business of the company 10 years from now.

 

Compare the growth in book value of Berkshire over the years with the individual returns on his investments then you should conclude that the differential is made up with his leverage and solid acquisitions made either at cheap prices or with a stock trading above book.

 

Cardboard

[Parsad]

Buffett makes money in large part by being leveraged and that has been going on for over 20 years now. His leverage costs him very little since it is insurance float that earns a little bit and borrowings done at very attractive rates. He is also making money by buying entire companies at low to fair prices with cash or sometimes using relatively expensive new shares.

 

If you look at the return on capital from his investments (Coke, Gillette and most others), you will be very disappointed and will think that buy and hold is a loser strategy. I believe indeed that it is unless you are in his situation managing 10's of billions and able to access capital for next to nothing. IMO, his investments are made more with the idea of earning a safe spread overtime than killing it in terms of returns like most of us are trying to do on this board. Like a bank if you will, but with a larger spread required and less risk than you would encounter normally for such differential. That is why he puts so much weight on being able to envision the business of the company 10 years from now.

 

Compare the growth in book value of Berkshire over the years with the individual returns on his investments then you should conclude that the differential is made up with his leverage and solid acquisitions made either at cheap prices or with a stock trading above book.

 

Cardboard

 

Yup...exactly right.  Same with Fairfax, Markel, etc.  They don't have to kill it...just do well...and the leverage takes care of the rest.  Cheers!

[ourkid8]

I am going to go on a limb and disagree with most of you guys as it really depends on the company. (I have to admit, these types of companies are EXTREMELY rare and when you find them to buy as much as you can)  There are some companies that have all the necessary characteristics to buy and hold for life and you will be extremely well compensated.  (Strong moat, pricing power, low capex, strong FCF generation, all cash being returned to shareholders etc...) The company in my portfolio that does not only meet but exceeds all those characteristics is Philip Morris International.  This was spun-off from Altria (Mo) and it has been arguably one of the greatest investments to buy and hold forever.  Take a look at their returns for the last 50 years and we should have similar returns for the next 50 years. 

 

Thanks,

S

[constructive]

I am going to go on a limb and disagree with most of you guys as it really depends on the company. (I have to admit, these types of companies are EXTREMELY rare and when you find them to buy as much as you can)  There are some companies that have all the necessary characteristics to buy and hold for life and you will be extremely well compensated.  (Strong moat, pricing power, low capex, strong FCF generation, all cash being returned to shareholders etc...) The company in my portfolio that does not only meet but exceeds all those characteristics is Philip Morris International.  This was spun-off from Altria (Mo) and it has been arguably one of the greatest investments to buy and hold forever.  Take a look at their returns for the last 50 years and we should have similar returns for the next 50 years. 

 

Thanks,

S

 

Would you hold PM if it went to 45x earnings?

 

Nobody thought KO was going to trade at 45x earnings, so they didn't need to worry about valuation, but it did.

[Vish_ram]

I've heard a lot of anecdotal evidence of common people making decent money using buy and hold (of consumer staples) over a long time. I've never heard of any trader type (naive) folks who have made fabulous money.

 

Another interesting fact is the returns from dividends, it averages more than 50%. These div mostly go to the buy and hold type and not to the traders/market timers.

 

A friend of mine, who is working in at&t (joined as technician at age 18, still is in lower level mgmt) for last 40 years, methodically bought shares, reinvested dividends and now gets 130K/yr in div alone. If he had traded, he would have lost money easily.

 

For a naive person, buy and hold of consumer staples is the best strategy.

[ERICOPOLY]

Did you factor in the tax hit if he sold coke?  What  were disclosure rules as I believe he was on the board?

 

Hedging against the index would have been an appropriate way to "exit" the position on valuation grounds, without triggering the taxation issue or worrying about disclosure rules. 

[Palantir]

I think opportunities like KO (Maybe not AS big) but great companies at very cheap prices do happen from time to time. (Cough GOOG last summer mid 500s). There are not many of them, but IMO you need to go as Paula Broadwell said, "All In".