Cisco Systems
Long-Term Buy-and-Hold

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By LeBeancountiere
July 27, 2001

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I see many posts about long-term buy-and-hold (LTBH) on this board and other boards -- and how that method does not work well for investing. According to some stock studies by Ibbotson Associates for the 70-year period from 1926 to 1995, if you owned the S&P 500 Index over any 1-year holding period the highest return would be 54.0% and the lowest return would be �43.3%. Moving to any 5-year holding period, the highest return would be 23.9% and the lowest return would be �12.5%. With respect to any 10-year holding period, the highest return would be 20.1% and the lowest return would be -.9%. For any 20 year holding period within those 70 years, the highest return would be 16.9% and the lowest would be 3.1%.

So, you could have bought the S&P 500 Index in the early part of the year 1929, watched the stock market crash late in the year and sold 20 years later with a positive return on investment. Hey, I heard that there was some kind of Great Depression and a World War over that particular time frame.

Let us put some time into perspective with respect to other things you might purchase over a lifetime, such as a home. You go out and buy the home and immediately say, "Hey, I want to sell this house in a couple of months and take my chips off the table with a nice profit." Oh, what was that again? Oh yeah, the tax experts say that the general rule under the tax code is that you have to own and live in a principal residence for at least 2 years to be entitled to the $250K/$500K exclusion depending upon whether or not you are married. Hey, 2 years just seems like such a long time. I could have dead money sitting in my home � how can I possibly own it for at least TWO WHOLE years?

Let us say that you own your own business. When you bought the business or started it you immediately said to yourself, "Well, I can see selling out in 6 months and taking my chips off the table." Is this the same thought process when buying an automobile or a rental property?

Moving to Cisco stock, assume that you are one of those dumb people like me and bought shares of the stock at the end of July 1994 when it was trading at roughly 18 times trailing earnings. And you did something really stupid like continue to hold the stock for 7 long years. Now let's see here, adjusted for stock splits, the price per share at the end of July 1994 was $1.17. Today this silly stock closed at a price of $18.70 (quite a bit lower than a year ago). According to my computations, I come up with an annual rate of return of only 48.69% (annual compounding considered as well). Boy, do I feel like an idiot holding onto this stock!

Lets say that you bought at the end of July 1995. Your adjusted purchase price would have been $3.10 per share and your annual rate of return would be less than if you bought in July 1994 -- that is, ONLY 35%. Boy oh boy, that sure could have been a dumb buy and hold play as well, right? Lets move to the end of July 1996. The adjusted stock price would be $5.75 per share. OOPS � you only would realize an annual rate of return of 26.7%. How can anybody build up any sort of net worth at this tiny rate of return? What about a purchase at the end of July 1997 at an adjusted price of $8.84 per share? What? You've got to be kidding me! Only 20.7% per year!

Oh yeah, that thing again that value investors like Buffett talk about � buying when the stock price is well below its intrinsic value. Well, I was stupid enough to not add shares in 1998, 1999 or 2000 because, quite frankly, it looked a bit overvalued. I have been buying more shares recently and in five or six years from now, I look forward to again seeing how incredibly stupid it was to do that.

Yes, in my first post on this board � post number 13062 on March 2, 2000, I tried to warn investors not to buy in at the stock price where it was trading at that time. (Boy, some Cisco investors were really kind of mad at me last year.) To get the valuation point across, I simply listed 8 little companies that most folks have heard of before (you know, companies like Abbott Labs, Merck, Coca-Cola, Gillette and Fannie Mae). The combined market cap of all 8 companies approximated the market cap of Cisco at that time � roughly $450 billion. Now some of those 8 companies I felt were undervalued at the time so I anticipated that things might look kind of interesting at a much later date.

What do you know? As of the closing prices last Friday, the combined market cap of all 8 companies was only $538.355 billion versus $454.73 billion. (I do not have to mention the market cap of Cisco last Friday.) Counting days and all, that works out to an annual rate of return of only 12.7%. Gee, that sure seems low. Oh yeah, let us benchmark against 3 indices. For the same time period, the Dow Jones Industrial Index went from 9862.10 to 10576.65 which is an increase of 7.2%, the Nasdaq Index went from 4590.50 to 2029.37 or a small drop of only 55.8%, and the S&P 500 Index went from 1333.36 to 1210.85 or a drop of 9.2%.

I am by no means perfect in my stock picking skills. In fact, I am pretty Foolish. I have even been spanked on some small cap stuff over the years but have done quite well on the large cap stocks. My point is that LTBH does work. Thank you Mr. Buffett for helping me understand that investing is about owning a share of a great business and being patient, which is part of the concept of investing in a businesslike manner.