Some financial advisors advocate a buy and hold forever strategy for individual stocks.
They cite such successful investors as Warren Buffett, Benjamin Graham, and John Templeton as staunch believers in a buy and hold forever approach.
Or financial experts tout articles like “The 7 Best Stocks for a Lifetime”.
As a good friend whose birthday is this week would put it, “Complete foolishness, I say.”
And she would be right.
I generally recommend buy and hold, but only for mutual and exchange traded funds. Not individual equities. I also believe that investors should periodically review their holdings. And, if necessary, to rebalance the portfolio to one’s current target asset allocation.
So why do I not like buy and hold forever with individual stocks?
Were These Successful Investors Truly Holding Forever?
I agree that many successful equity investors take a long-term perspective. That is part of my own investment philosophy.
But long-term does not mean forever. Either literally or even in a typical investor’s lifespan of (say) 40 years. And Warren Buffett often sells investments.
Successful value investors – Buffett, Graham, Templeton – do usually take a long-term perspective (the exception are some value investors who trade based on short-term anomalies that temporarily create under-valued opportunities). They focus on companies with strong management, well run operations, an excellent business model, products/services with strong revenue potential, industry leading positions, etc.
In short, strong successful companies with consistent long-term earnings growth potential.
But again, long-term does not necessarily mean forever.
The world changes over time. Companies that are strong today may lose their competitive advantage in the future.
Smart value investors continually assess their holdings to ensure their investments still possess strong potential.
What Do I Mean?
A good example is Eastman Kodak. A company that met many criteria on a value investor’s list.
Strong products – selling the Brownie camera, not too mention all the film, innovation – inventor of the first digital camera in 1975, successful track record – member of the Dow Jones 30 since 1930, and so on.
A nice company to own for the long-term.
In the 1960s and 70s, you likely bought a camera from Kodak. In the 2000s, would you buy a digital camera from Kodak? Possibly. But you would look at Canon, Panasonic, Nikon, Sony, Olympus, Pentax, etc. And for most customers, Kodak did not close the sale. Which may explain why Kodak just announced that they were exiting the digital camera business.
In 1975, Kodak invents the digital camera. In 2012, Kodak leaves the business. 37 years is a long time. But it is not forever.
The business world is not stagnate. Factors that impact companies constantly change.
It is pure lunacy to think otherwise.
Impact on Investors
As an investor, we can also see how buying and holding Kodak paid off.
Not great if you held forever.
As an investor, you must constantly assess the future potential of any company at that moment in time.
Kodak probably looked like a superb investment at times in its history. Great products, industry leader, new technologies. However, would most investors consider Kodak as an industry leader with great products today?
Times change. Companies change. Expected future share performance will change.
Do not buy a company stock and throw the certificate in your safe deposit box. Always examine its future prospects on a periodic basis. If the fundamentals change to the point where the company’s potential is doubtful, then you need to consider selling.
But take a longer-term perspective in your analysis. Otherwise, you will be churning your portfolio as you constantly flip investments seeking the next great asset.
What About Funds?
“Okay, I see buy and hold forever with stocks might be problematic. But what about you and your buy and hold with funds? Isn’t this same issue?”
Maybe. Maybe not. It depends on the company and the index.
Consider Kodak. It became a component of the Dow Jones 30 in 1930. Outside of General Electric and General Motors, the longest tenure of any company. But by the 2000s, the company was clearly weakening. In April 2004, Kodak was deleted from the Dow Jones (along with AT&T and International Paper) and replaced with Verizon, Pfizer, and American International Group.
Although a little later to the party, Kodak was also deleted from the Standard & Poor’s 500 index in December 2010.
With various indices, this is a normal process. As companies meet index criteria, they may be included. As companies fail to adhere to the criteria, they are deleted. You may buy just one single index fund, but its components will change over time.
While the criteria do not relate to profitability or share appreciation directly, they do in an indirect fashion. For example, market capitalization is often a criterion. If a company issues 1 million shares at $5, its capitalization is $5 million. If the company is successful, its share price will rise and so too will its capitalization. That may allow it to meet minimum requirements for certain indices.
That is why I like the buy and hold strategy for funds but not for individual stocks.
If you buy and hold a stock forever, you had better hope that your company evolves well over time in a changing world. Not many excel forever.
But if you buy an index fund, you can hold it forever. Safe in the knowledge that over time, weakening companies will exit the index and be replaced by stronger firms.