FOOL ON THE HILL: An Investment Opinion
Investing for the Long Haul

The only kind of investing we talk about at The Motley Fool is long-term investing. It's what we believe in. If you're going to invest for the short term, however, know you're playing a game based on market sentiment, not on business fundamentals.

By Richard McCaffery (TMF Gibson)
August 24, 2000

One of the reasons we talk so much about time horizons at The Motley Fool is because the differences between short-term and long-term investing are so sharp, not only in terms of performance but in terms of the terrain.

The fact that they are often confused led me to this topic, though I'm risking telling people something they already know.

If you invest in companies for the long haul -- and that's the only kind of investing we talk about at The Motley Fool -- you're buying shares of a business you expect to hold for a minimum of five years, hopefully a lot longer.

It's not easy, but here's what you do. Take a company like Station Casinos (NYSE: STN) and learn how it makes money -- that it operates casinos in the Las Vegas area and focuses on the locals market, which shelters it from the expensive arms race the big casino operators are engaged in; learn that most of its floor space is dedicated to slot machines, since slots have super-high margins, and learn that in Clark County, Nevada the barriers to entry for opening off-strip properties, where Station operates, are getting higher. This is a trend that helps protect Station's franchise.

It takes a while to get familiar with a company and its industry, but the long-term benefits of investing in quality companies are hard to beat. And if you like studying and learning about businesses, well, you're having fun at the same time.

Of course, there's no guarantee this will always work. Say you plunked down $1,975 on December 31, 1993 to buy 100 shares of Station. As of December 31, 1999 you had earned a woeful 2.1% annually on this investment, leaving you with $2,243.75 in your pocket. Not exactly a great return. Heck, some banks pay more interest than that.

But, in general, that's what you try to do -- pick companies that have competitive advantages. For me at least, this is the only way to invest: Based on the long-term business fundamentals of a company that interests me.

If you do this, the success of the company as an investment is based upon how well the business performs. In technical terms, it's based on how much cash the company generates over a given period, and in really technical terms, it's based on the present value of the company's future cash flows, discounted at a certain rate to reflect the riskiness of the investment. That's what you're paying for -- a stream of future cash flows.

If you want to go the other route, gambling on the short-term performance of a stock, then it's worth knowing the game you're playing, and that you're walking on different soil.

In the best-selling book, Stocks for the Long Run, Jeremy Siegel, finance professor at the Wharton School of Business, said it better than I can. The following paragraph really opened my eyes to the difference between short-term and long-term investing:

"Accordingly, success for short-term investors comes primarily from predicting how the investing public changes its view of stocks in the future, and quite secondarily from the cash flows realized by the investment itself... Although investment advice geared to the short run hinges on predicting the sentiment of other investors, in the long run you can ride out the waves of investor sentiment. Winning with stocks requires only patience, not foresight."

This is the bottom line for investors in deciding a time horizon. Do you want to base an investment decision upon your interpretation of business fundamentals over the long term (admittedly a challenging exercise), or upon what you think other investors will think?

For me, there's just too many cooks in the kitchen to favor short-term investing. I can't control how other investors will think, nor am I interested in trying. It's like planting a garden based on what vegetables I think my neighbors want to eat. Not only will I end up with food I don't like, but what if my neighbors change their minds? Instant compost heap.

This method relies far too much on the hand of fortune for my liking, yet people pay good money for short-term advice everyday.

Consider that on May 3, a Goldman Sachs analyst downgraded Wal-Mart (NYSE: WMT) and a number of other discount retail giants because of concerns over consumer spending and signs the economy might be slowing.

The analyst downgraded Wal-Mart to 'market outperform,' removing it from the company's 'recommend list.' Long term, however, he didn't change his opinion on the company.

Since the downgrade, the stock is down nearly 8%. Therefore, the analyst's call is probably considered a victory, and maybe even earned investors a few bucks (though with trading costs and taxes I seriously doubt it).

But as Wal-Mart's stock has declined, the business has performed quite well. Second-quarter sales grew 19.9% to $46.1 billion, and earnings per share increased 29% to $1.6 billion. Its Supercenters continue to gain momentum, and international stores in the U.K., Mexico, and Canada performed strongly. For the company, the last three months have been a victory whether the market recognizes it at this point or not. (Of course, it's also possible the market was just repricing the shares based on their future outlook, and that Wal-Mart needed a little wind let out of its sails. I don't know the company well enough to say.)

The point is that over the short term, it's not uncommon for a company's stock to underperform the business. Over the long term, however, the two converge.

I don't know what investors will think about Wal-Mart in three weeks, three months, or three years, and I don't want to risk my money investing on that basis. I just wouldn't feel like I had done my homework or that I was investing in an outcome I had any reasonable chance of predicting.

Related Links:

  • The Buy and Hold Apocalypse, Fool's School