2 Scenarios Where Buy and Hold Rarely Works

Watch stocks you care about

The single, easiest way to keep track of all the stocks that matter...

Your own personalized stock watchlist!

It's a 100% FREE Motley Fool service...

Click Here Now

Here at The Motley Fool, we firmly believe that buying business over the long haul gives investors the best chance for succeeding in the stock market. There are countless different investing methods vying for your attention -- including day trading and technical analysis platforms -- but, as fellow Fool Morgan Housel noted in his research back in March, history is very clear on the fact that holding over a long period of time gives investors the best chance at making money. In fact, according to Morgan, if you purchased stocks once a month since 1871, nearly 88% of your investments would be up after a 10-year period.

There's certainly undeniable strength in those figures; however, it's just not that simple. There are, in fact, two scenarios where buy-and-hold investing may not be your best recourse and could actually be downright detrimental to your portfolio.

1. Capital intensive businesses
Capital intensive businesses are ones that require a huge investment to turn what is often a marginal profit at best. Perhaps the poster child for high capital investment industries is the airline sector.

In order to be profitable and make a difference, airlines are required to purchase sizable fleets to service multiple markets. Unfortunately, airplanes aren't cheap and this usually requires providers to go deeply into debt in order to finance these purchases. US Airways (NYSE: LCC  ) , for instance, declared bankruptcy twice last decade and even today still boasts net debt of nearly $2.4 billion.

Source: Jun Seita, 

United Continental Holdings (NYSE: UAL  ) , made up of a merger between United and Continental, was brought about to realize cost synergies and better compete against larger national carriers. Surprisingly, though, as my Foolish colleague Adam Levine-Weinberg points out, the United Continental merger actually resulted in extra costs last year rather than savings! 

But it isn't just airlines that long-term investors need to exercise caution with. Biotechnology companies are also capital intensive businesses as well.

It often takes anywhere between 11 and 14 years for a drug to go from a laboratory setting, through preclinical and clinical trials, to eventual approval by the Food and Drug Administration. In addition, the average cost of each approved drug, including all drug failures, according to Bernard Munos of InnoThink Center for Research in Biomedical Innovation, is approximately $4 billion. It takes a lot of money, a ton of research, and certainly a little bit of luck to get a drug approved, and even then that's no guarantee that it'll be a success. Factors like pricing, competition, and target audience also play into the eventual success or failure of a drug.

Dendreon's (NASDAQOTH: DNDNQ  ) castrate-resistant prostate cancer treatment Provenge is a perfect example of how pricing and competition can get in the way. Although its drug was easily approved by the FDA after delivering a four-month increase in overall survival, sales of Provenge, which runs $93,000 for the three-course treatment, have struggled because physicians are concerned about not being reimbursed for prescribing Provenge. Furthermore, competing drugs are cheaper on an annual cost basis.

Keep in mind this doesn't mean all airlines or biotechnology companies are poor investments; it just means you have to be very picky with your research when it comes to investing in capital intensive industries.

2. Commoditized industries
There are two types of industries that are subject to commoditization and require investors to exercise more caution than usual: the technology sector and metals and mining.

The concern with the technology sector is that it's always evolving. The time period between development cycles in everything from smartphones to laptops is shrinking to the point where there's soon going to be no differentiable gap anymore. For the tech companies themselves, that could be great news, as it keeps consumers excited about potential new products. However, from an investable standpoint it's terrible news because it creates high levels of competition and more efficient production lines that deliver a precipitous downslope in product costs.

Memory-chip maker Micron Technology (NASDAQ: MU  ) is one such company that's wholly dependent on demand from the PC and electronics industry, and is completely at the mercy of flash memory and DRAM prices. It can expand its production or reduce its costs as DRAM and flash prices rise and fall, but it doesn't have the tools necessary to break the bonds associated with the cyclicality of the tech replacement cycle.

With regard to metals and mining, many of the same principles are in play. Spot metal prices have a propensity to move higher when the economy is expanding and pull back when it's contracting, placing many spot prices in somewhat predictable peak-and-trough patterns, but making it very difficult to hold them over extended periods of time like a decade. Global gold miner Newmont Mining (NYSE: NEM  ) , for example, has delivered shareholders just a 75% return since 1988, because its demand can ebb and flow with the economy and it's completely at the mercy of spot gold prices. Comparatively speaking, a 30-year U.S. Treasury note and the inflation rate would have netted you a better return over that period.

Also, many of the most commonly investable metals, like silver and gold, are used as electrical conductors in electronics devices, which, as I just noted, are easily commoditized. The natural evolution of the tech cycle has the ability to affect the demand for certain metals in both positive and negative ways.

Again, as with capital intensive business, this doesn't mean there aren't good long-term investments to be had in commoditized companies -- they're just much tougher to find.

Think long and prosper
The idea of pointing out these two scenarios isn't to get you thinking short-term, but to get you to recognize that variations do exist and it takes more than throwing a dart to pick out a winning investment. Keep that in mind if these sectors are on your radar, but always remember that with regard to investing success, history is in the favor of the buy-and-hold investor.

Is Dendreon due for a resurgence?
Shares of Dendreon have surged in recent months, with the stock gaining new life from the depths of late 2012. Has the company really solved its underlying problems, or are investors setting themselves up for more disappointment? Our new premium research report on Dendreon answers these questions, and many more, while also outlining just how Dendreon intends to regain its former glory. Claim your copy by clicking here now.

Read/Post Comments (0) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2426527, ~/Articles/ArticleHandler.aspx, 5/25/2016 5:29:21 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Sean Williams

A Fool since 2010, and a graduate from UC San Diego with a B.A. in Economics, Sean specializes in the healthcare sector and investment planning. You'll often find him writing about Obamacare, marijuana, drug and device development, Social Security, taxes, retirement issues and general macroeconomic topics of interest.

Today's Market

updated 8 hours ago Sponsored by:
DOW 17,706.05 213.12 1.22%
S&P 500 2,076.06 28.02 1.37%
NASD 4,861.06 95.27 2.00%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

12/31/1969 7:00 PM
DNDNQ $0.03 Down +0.00 +0.00%
Dendreon Corp CAPS Rating: *
LCC $0.00 Down +0.00 +0.00%
US Airways Group,… CAPS Rating: *
MU $11.49 Up +0.35 +3.14%
Micron Technology,… CAPS Rating: ***
NEM $31.74 Down -2.09 -6.18%
Newmont Mining Cor… CAPS Rating: ***
UAL $44.99 Up +0.79 +1.79%
United Continental… CAPS Rating: **