FOOL ON THE HILL: An Investment Opinion
All of the sudden, now that nothing seems to be working in the marketplace, some of the conventions are being hauled out and questioned. One is whether buying and holding a stock for the long term is a better way to invest. The answer is that it depends, because one could always be buying and holding a substandard company. But the current drop in share prices, particularly among technology stocks, is hardly a refutation of the power of efficient investing.
Yesterday, Brian Graney (TMF Panic) wrote a Fool on the Hill article that I believe should be required reading for anyone who is interested in investing in equities, particularly the ones that lie within the hot spot du jour. In it he described just how some of the best companies from an operational perspective could be horrible, underperforming investments if you overpay for them.
Unfortunately the investment public seems to bounce from trendy sector to trendy sector, each time willing to pay whatever price in order to be in on the upcoming revolution. Earlier this year it was B2B. Last year it was dot-coms. We've also had telecommunications carriers and wireless. And now the optical networking and biotechnology companies seem to be able to do no wrong. This goes all the way back to the Nifty Fifty, the "one-decision" stocks that people were buying at whatever price in the 1970s. Thing is, each of these revolutions is still coming, or is underway, and yet these stocks have risen and, in most cases, fallen once again.
At some point, the market has appropriately discounted ALL future cash flows, and by investing in certain companies at certain prices you are nearly guaranteeing yourself to underperform the market -- either by a little or by a lot. Each of the above sectors, including dot-coms, are seeing their revenue levels skyrocket, even as we speak. But those who bought at the top are probably years, if ever, from gaining a substantial return on their investments.
Valuation matters. Valuation has always mattered, valuation will always matter.
So why am I about to argue that long-term buy and hold (LTB&H) is just as valid as it ever was? Because at its root, it is a strategy that combines the simplicity of only having to make one decision, the efficiency of limiting taxes and other frictions, and the safety of requiring you to be very, very careful about where you put your money.
"Wait, what was that last part? Careful about where I put my money? What the heck does that mean?"
It means that long-term investing is only effective if you pick good companies. Not just good companies. Great companies. The greater the company, the less valuation matters. Valuation considerations certainly can improve your returns, and it is stupid to run out and pay hundreds of percent over a company's intrinsic value unless you are sure that somehow it is still "underpriced" to its future cash flows. The common retort to criticisms of LTB&H is that Cisco (Nasdaq: CSCO), Microsoft (Nasdaq: MSFT), and others would have, historically, "never" been overvalued. But by the same token, at this point there are boatloads of companies out there that have never been undervalued.
Over the last few days I've done a little grave dancing. I browsed around some of the boards of companies that were yesterday's high flyers that are today at or near single digits. Internet Capital Group (Nasdaq: ICGE), Netbank (Nasdaq: NTBK), TheStreet.com (Nasdaq: TSCM), ICG Communications (Nasdaq: ICGX), to name a few. There are hundreds out there, but what they have in common is at their highest points, whenever there was a dip, some investors would puff out their chests and call it "a buying opportunity," or a "fire sale," or something similar. And I do not doubt for a second that at least some of those investors had spent hours upon hours working over cash flows and market research and were convinced beyond a shadow of a doubt that the company was going to succeed.
Trouble is, right now it seems as if they were wrong. Or at least that their read on the market and speed of market growth for these companies' services was incorrect. I'm generalizing here -- some of the above companies are likely to succeed, some will probably fail. But all of them will have a grave difficulty providing market-beating returns to those investors who have lost 96%, 89%, 94%, and 99% of their value from where they bought these companies.
These investors, however, were just as unlikely to achieve market-beating returns even when the companies were at their highs. They were practicing long-term buy and hold on the wrong companies. Internet Capital Group, at a maximum valuation of $39 billion, was valued so highly that its chances of underachieving expectations at some point were nearly 100%. The end result, its stock price getting clobbered, came sooner rather than later. Regardless of the timing, however, a long-term view mantra was not going to stop it.
The thing is that now is the time in which some excellent values have presented themselves. Now is the time when a long-term view could give an investor a huge advantage, because some babies have in fact been thrown out with the bathwater.
So the LTB&H mantra misses one key portion of the equation. Buying and holding great companies will not generally help you unless a) your research tells you that the company is truly sui generis in its management, services, and products, and b) that you buy the company at a level that holds some reasonable promise for equity gains.
This much is true: Investor madness about industries will change. When it happens, those companies within the sector that falls from favor will see their share prices drilled. This is as external to the business as the original rise was in the first place.
There has been this general feeling about the equity marketplace in the last few years that you put your chips down and someone comes by and starts shoving money into your pockets. There have been periodic fits in which the marketplace reminds us to be humble; perhaps this one is it. But those who are really being humbled, humiliated, and crunched are those who decided that they could buy and hold just any old company and it would turn out OK. This is completely in contravention of the cycles of business. IBM (NYSE: IBM) wins, Digital loses. IBM loses, Microsoft wins.
Buying and holding is no guarantee for success. Even buying and holding great companies is no guarantee. Sometimes great companies do not remain so, a la Polaroid (NYSE: PRD), and sometimes they do, like Coca-Cola (NYSE: KO). In buying a stock for the long term, you'd be wise to make sure that the company is at least built for the long term.
This said, a market collapse (or, as I see it, further reduction in last year's froth) is no reason at all to begin slaying the sacred cow of LTB&H. In fact, we're still so far above from where equities were priced even two years ago on EVERY major index, only those who have held companies for longer than this are in a position to comment whether it is working or not.
Bill Mann, TMFOtter on the Fool Discussion Boards