Randy Befumo (MF Templar) explores whether or not the
"buy and hold approach" remains valid. The series originally appeared in
the Fool's Evening News in August of 1996, and was designed to be a comprehensive
response to a spate of nonsense which questioned the long-term value of stocks
and called for individual investors to throw their money in the bank or go
to market-timing professionals.
Episode 1: Introduction
With every market correction comes a flurry of
pronouncements that the so-called "buy and hold" approach is dead. Without
even an attempt to define what is meant by the phrase "buy and hold," a bevy
of journalists armed with all sorts of self-serving quips from traders and
market timers descends upon the heartland of America. They then try to scare
individual investors into putting all of their defined benefit retirement
plans into the "money market" option, warning that stocks are "dangerous."
The latest in a regrettable series of nonsense appeared in the Washington
Post's Investing column over the weekend, but this is simply representative
of a growing sentiment in pressrooms and on trading floors across the country.
"Buy and hold is dead," they whisper. Now, it seems, only traders and market
timers can make money. Individual investors are best-served by forking over
their hard-earned savings to "financial professionals" who can actively manage
the money appropriately, lining their pockets the whole time.
What is the "buy and hold" approach? Most people now nattering on about the
subject in the wake of the recent market correction take it as "buy at the
top and hold forever because you cannot admit you made a mistake." Others
who have taken thinkers like Peter Lynch, Warren Buffett, Charles Munger
or Phil Fisher at the facest of face values have talked about the "buy what
you buy" school of investing that has individual investors mindlessly purchasing
the shares of companies whose products they use without regard to fundamental
value, holding them forever. All focus on the supposition that saying "buy
and hold" means that people are purchasing shares without regard to fundamental
value because if they hold for the "long-term" they are guaranteed to make
money.
Frankly, this is a really shallow interpretation of the maxim "buy and hold."
The buy and hold approach should focus on selecting quality companies with
current market values that are at a discount relative to their underlying
economic value. By accumulating these issues selectively over time and holding
them, an investor minimizes transaction costs while maximizing the possibility
of enjoying the long-term returns generated from the business. With the
overwhelming correlation between corporate profit growth and long-term share
price appreciation, there is quite a bit of wisdom in this approach, if the
returns of a financial asset over time approximate the returns of the underlying
company, either in profit growth or return on equity (ROE). (The reason why
ROE is important is that excess cash generated by the business can be used
to enhance earnings per share (EPS) growth through regular and systematic
stock buybacks.)
The buy and hold approach minimizes costs and allows the investor to participate
in the long-term growth of a quality company *plus* any change in its market
valuation relative to its intrinsic economic value *providing* they have
purchased the shares at a significant enough discount. Rather than simply
setting up the buy and hold approach as a straw man to be easily beaten apart
by spurious market timing logic, a comprehensive look at the approach and
the alternatives and a serious questioning of which is really better for
the *individual* investor is what the Buy And Hold Apocalypse? series will
do.
Acknowledgement: The Fool owes a special thanks to Legg Mason Fund Advisors'
Bill Miller for information in this article and other articles in this
series.
Next: A Time to Measure »
See Also