Buy and hold. Man, there are days when I hate those words.
I know what you're thinking: Isn't buying and holding stock in great companies the path to outsized returns and long-term wealth? Yeah, of course it is. But as I've witnessed, the phrase can be taken too far. It can become investing code-speak for lazy. And I'm not talking about strategic sloth, but the kind of zoned-out, couch-potato, who-cares-about-my-returns laziness that can really cost you. I know because I gave away a sure 20-bagger for no other reason than I was lazy and stupid.
Forget the 401(k)
I feel like I should be writing this in a bar, with a soft piano playing behind me, you to my left, and Smitty serving us a pair of cold brews. Oh, and you're buying. (Look, man, I'm the one who gave away the 20-bagger, OK?)
It was Halloween 1997 when I first bought shares of Sun Microsystems (Nasdaq: SUNW ) as an employee. It was a sweet deal, too: I was getting a 15% employee discount and buying at the lowest price point from five months after my enrollment period as a new employee. Frankly, I liked the pitch so much that I decided to forgo Sun's generous 401(k) for the stock purchase plan, figuring I might do better. How right, and wrong, I was.
My one and only buy -- I left the company before I could pick up more stock -- netted me 32 shares of Sun stock at $24.34 per stub. I felt pretty confident that I made the right choice after seeing the purple-and-white confirmation letter in my inbox at work. By September 2000, I was swimming in pride. The stock had split twice while the value of my shares had launched into the stratosphere, rising to $128.63. After adjusting for splits, on that day I had earned a return of 2,012%, or 20 times my original investment.
We can retire on this, right?
My problem was that I didn't act like an owner: I didn't read one 10-Q; I didn't seek to understand what could go wrong with the business; I didn't perform a proper valuation. Heck, I barely read the earnings releases.
But I sure did get sucked in by hype like this. And I allowed my prejudice to cloud my judgment. Even though I had been a lousy Sun employee, I thought highly of CEO Scott McNealy and his management team.
I also got caught up in the dream. Sun's stock was rising so far, so fast that I did the math and figured 10 years of outsized returns would allow us to retire early. Considering that we were still climbing out of debt, this fantasy was incredibly alluring.
So, as the stock cratered 57% to an abysmal $27.88 -- the last split had occurred on Dec. 5, 2000 -- I held on, confident that my Sun-drenched retirement dream hadn't been crushed. After all, I was still up more than 800%! But, alas, the Sun was still setting.
A not-so-happy new year
Since we're all already familiar with what happened in 2001, it won't surprise you that by the close of that year I saw my shares down (again) more than 50% to $12.30. But that was still a four-bagger. And, yeah, I was still hanging on, despite the ski-slope chart.
As conditions worsened in 2002, my champagne wish and caviar dream turned into a tap water and tuna fish reality. In July, I sold at $4 per share, for a gain of... wait for it... 31%. Had I held much longer, I might not have earned a dime.
I should've known
The tragedy is that this didn't have to happen. That's not to say that I could have called the top for Sun's stock, by any means.
But even that hyped-up Kiplinger's piece told me to watch out even as it recommended Sun's shares: By December 1999, Sun was selling for more than 50 times the Street's consensus earnings estimate. Even the most optimistic prognosticators were predicting no more than 20% growth over the next few years, meaning Sun's stock was trading for an outrageous premium. And there were plenty of other signs, for example:
- From 1998 to 1999, Sun's cost of goods sold actually rose faster than sales, 20.3% to 19.7%. (This might have indicated overly optimistic management.)
- As of the March 2000 quarter, Sun's debt load rose to more than $2 billion from $385 million in June of 1999. (It was unusual for tech firms during the dot-com boom to be taking on debt, especially this much debt.)
- Sun's stock had traditionally traded for less than the average P/E for the S&P 500. This was true even through 1998, when it trailed the S&P by more than 10 points, according to Morningstar. But then, in 1999, that changed, and the switch was dramatic. Sun suddenly traded for nearly 20 points more than the market. (This should have set off alarm bells in my head. No stock ever maintains gravity-defying valuations.)
Remember, all of this information was available before Sept. 1, 2000, the fateful day Sun's stock was delivering me the virtual 20-bagger that I never collected. (Are you listening, Travelzoo (Nasdaq: TZOO ) investors?)
Even if I did still believe in the stock, I could have taken half the money and let the rest ride, happy in the fact that I'd pocketed a very comfortable gain no matter what else happened. Or I could have done what David Gardner did when he recommended to Motley Fool Stock Advisor subscribers that they sell Netflix (Nasdaq: NFLX ) when the stock went too far, too fast. David's reasoning was that it is usually better to collect capital gains when the valuation story no longer makes sense. (David, where were you when I needed you?!)
Buy and pay attention
The good news is that during the nearly five years I owned Sun stock, it beat the market. In fact, it walloped it: The S&P 500 lost money from the day I bought the shares till the day I sold them. Yet Sun earned me a 31% return on my money. So, I can't really complain. But I can make sure I do a better job of bagging the 20-bagger next time, if there is a next time. How? By not just blindly buying and holding.
The lesson I had to learn was that buy and hold doesn't mean buy and do nothing. It means accepting the ownership role you take on as a shareholder. That includes reading financial reports, asking questions, voting on issues brought before shareholders, and so on. So maybe it is time to retire the phrase "buy and hold" and replace it with something that more accurately describes the job of ownership, something like "buy and pay attention."
Indeed, had I paid attention and acted like an owner with Sun, I'd be a much richer ex-owner today.
David Gardner's sharing the same philosophy that helped him earn a 50-bagger on AOL in his new newsletter,Motley Fool Rule Breakers. A free trial is yours for the asking.
Fool contributorTim Beyersis committed to stalking the next multibagger. Tim owns no shares in any of the companies mentioned, and you can view his Fool profilehere. The Motley Fool has adisclosure policy.