YCG Investments
“If you buy above average businesses at below average prices, on average, we believe you should come out ahead.” — Brian Yacktman

May Buy-and-Hold R.I.P.?

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In the early part of the 20th century, the average mutual fund turnover was in the range of 20% to 10%, meaning the average holding period of a stock was 5 to 10 years. This turnover has increased to over 100% (meaning a completely different portfolio every year), and spiked even further last year. There are many reasons for this, but in large part, it’s because over the years, investors have increasingly become short-term oriented. In 2006, USA Today cited a survey conducted by Retirement Corp. of America wherein they asked 1000 individual investors “How long are you willing to wait before moving your money from a poorly performing investment?” More than 60% responded less than a year!

An onslaught of news articles have questioned buy-and-hold investing – a concept misunderstood. One argument has been if you were forced to liquidate (perhaps you were entering into retirement, for example) during a crash such as this past year, time actually became your enemy. I agree – time can go to your detriment. While time can provide an opportunity to recover from a drop in prices, on the other hand, it also gives you more time to encounter a market crash. As Keynes put it, “The market can stay irrational longer than you can stay solvent.” But this point is irrelevant – buy-and-hold was never meant to imply that the longer you hold stocks, the risk of selling at an inopportune time becomes eliminated.

The other argument goes something like this, “If I had bought the S&P 500 a decade ago, I would have gone nowhere.” But this fact does not discredit the notion of long-term investing. The problem with this logic is it never takes into account the number one underlying principle that led to the very concept of buy-and-hold, specifically, buying a security below its intrinsic value. If you buy an undervalued security, then you can hold it, wait, and regardless of short term price fluctuations, eventually the value will be recognized over time.

Thus, the key ingredient missing here is the price paid at entry point. Many have misunderstood the concept, incorrectly thinking it meant long-term returns were guaranteed if you simply owned stocks for a long enough time period, regardless of purchase price. It would be ridiculous to overpay for a security under the pretense that through the passage of time, the risk of buying an overvalued security goes away. In fact, that is precisely where risk steps in – overpaying for a security, no matter how good the business.

For example, despite their growth, the internet stocks that successfully survived the past decade but were purchased at the peak of the dot com era may never see those peak prices again. Buy-and-hold simply makes no sense when a stock price jumps way ahead of its value. This is why the theory appears defunct. In general, people have been overpaying for stocks for over a decade.

However, we, and many other value minded investors, can humbly acknowledge that we have handily compounded money over the past decade by following basic value principles.

To clarify buy-and-hold, we like to extend the phrase to “buy-and-hold until price converges with value.” This is why long-term investors who understand the meaning of buy-and-hold have experienced more turnover this past year – the more volatility in the markets, the larger the disconnect between business value and stock price. Nevertheless, true value investors remain long-term thinkers.

The concept of buy-and-hold stands strong under the assumption that you buy at a margin of safety. Therefore, do not give into the campaign touting that long-term investing is dead. In fact, ironically, the best time to buy-and-hold the market is likely when there is much negativism about the concept, and the best time to get out is likely when everyone praises the notion!

Disclaimer: The specific securities identified and discussed should not be considered a recommendation to purchase or sell any particular security. Rather, this commentary is presented solely for the purpose of illustrating YCG’s investment approach. These commentaries contain our views and opinions at the time such commentaries were written and are subject to change thereafter. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. These commentaries may include “forward looking statements” which may or may not be accurate in the long-term. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable. Past performance is no guarantee of future results.

Posted by: Brian Yacktman | September 30, 2009 | Permalink

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