Sunday, January 06, 2008

Buy and hold forever?

HH passed me an excellent article on buying and hold fallacy which I linked it here.

The idea of buying and holding is what long term investors would like to do. Before anyone just go to the stock market and buy anything stocks, and proceed to hold it forever, I think here's a few pointers to take note:

1. Buy and hold works good for companies which are fundamentally sound. I think before you adopt the buy and hold strategy, you must decide whether the company will still be around for long and whether the company can still make money in the future. It still boils down to analysing the business. But jeng told me an interesting thing, economy changes every 5 years or so, thus there is no need to look for 10 years data since the company might be a very different one 10 years later. A good example is GE, this is one company that continually changes according to the demands of the world. Did you know that Thomas Edison started a company that eventually became GE? That was way back in 1890s. Or locally what about Eng wah...who would have though that they changed their core business of movies and went into biotech last year?

2. Point one talks about survivorship of the company. Point 2 talks about survivorship of the industry. Who knows what might happen in the future? Would we enter a time where genetic manipulation is so rampant that we can engineer ourselves not to grow beard, thereby putting Gillette out of business? Or we ran out of oil and all the refineries like SPC, Exxon-mobil, Shell go bust? We cannot foresee what will happen in the future...perhaps the next biggest sector to look out for haven't been invented now. Think cryogenics and outerspace travelling.

3. Buy and hold is good if you have a margin of safety. Holding when your entry price is very low gives the holder a sense of security and quiet confidence. Imagine buying at a high (trading buy) and holding it for long. Anyway, margin of safety doesn't guarantee good returns (though it usually does), it just increase the safety of our capital.

4. There is a time to sell for long term investors. The time to sell is when the stock reaches its fair value. I might have more to say when I know how to determine the fair value in the first place. My idea of it is to determine a fair value, say 100%, then proceed to buy at 40% to 60% (your margin of safety), then sell at 100% when the catalyst comes in.

But the article did raise a certain point which I find interesting. The hottest stock now - Berkshire - might not be the hottest in the future. Who knows? I guess instead of buying and holding individual companies and take the risk, perhaps a less risky approach is to buy index. Buy and hold index I mean. Then again, who knows? Historically stocks have always go up despite the fluctuations and market crashing events. We would never know if the stock market will always go up or it haven't come down.

To summarise, just keep an open mind. Question your assumptions periodically. Nothing beats an open enquiring mind.


TheKen said...

opportunities lost can be alot !