The Buy and Hold Apocalypse

Introduction

Buy and Hold

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.