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Value Investing for Mothers-in-Law (And Everyone Else): What 'Buy and Hold' Really Means

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A new column explains that "buy" doesn't mean "buy any random thing," and "hold" doesn't mean "never sell it under any circumstance."

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Editor's note: This is the first in a multi-part series explaining value investing to novice investors. Please leave us your thoughts or suggestions in the comments section below.

My mother-in-law is known to my kids as Doodles. The name's origin is a long story, but what's important here is that she is extremely smart and a very capable businesswoman (she doesn't go by "Doodles" professionally). Still, when we get together at the holidays, the stock market questions start:

"What's going to happen in the market?"

"Should I buy XYZ stock? My advisor said its chart indicates it is ripe for a breakout."

Doodles, I have no idea. I mostly engage in long-term value investing based on the fundamentals of the underlying business. So, maybe I should explain what that is so that you don't mistake my silence for rudeness or me unfairly withholding magical stock market knowledge from my dear family. We can skip that part of the conversation and go straight to talking about my way of investing, or you can just let me concentrate on pouring gravy directly into my mouth.

(For the record, Doodles is just a proxy for every social acquaintance who has ever asked me a question about the stock market. If I am addressing a dumb statement, assume that it was an insane distant relative who inspired my commentary. If the question is nuanced and complicated, assume it was the work of Doodles.)
Two of the comments I hear all the time go something like this:

"I am down 50% in Terrible Business, Inc., but I am going to keep it because I am a buy-and-hold investor,"

and

"I heard a professional on TV say that the last 10 years have proven that buy-and-hold investing is dead."

Both of these statements make a fundamental error in the interpretation of the concept of "buy and hold." They both assume that "buy" means "buy any random thing" and that "hold" means "never sell it under any circumstance." Aside from being a bad way to invest, "buy any random thing and never sell it under any circumstance" isn't a very catchy phrase.

In fact, most stocks are not very appropriate for buy-and-hold investing. It only makes sense to plan to hold a business that is worthy of, you know… holding. Warren Buffett would look for such a business to have a "moat" -- what others might call a competitive advantage. As with castles, the bigger the moat, the more protection it offers. For a business, this might result in stickier customer relationships, faster and longer-than-average periods of revenue growth, or higher profitability relative to the rest of its industry.

These businesses tend to not be in fast-changing industries, because every time the industry shifts it's simply one more chance to get it wrong and screw up your competitive advantage. A business like Sysco (NYSE:SYY), the dominant restaurant supply distributer, has a strong moat based on its scale and honing its business processes over many years. A major component of success in its industry is route density. The more customers Sysco has in a given territory, the more it can optimize the driver's route and the truck's load. It can also use its scale to order from its suppliers in optimized quantities and at volume discounts. Lower operating expenses give Sysco room to price just below its competitors and still be more profitable. It is extremely difficult for a competitor to replicate this advantage.

This is not to say that faster moving industries can't still have moats. Motorola Solutions (NYSE:MSI) operates in the communication infrastructure and device industry, selling to governments and commercial customers. While advantages here might seem fleeting at first glance (as the technology changes so rapidly), it is very difficult for many of MSI's customers to switch providers. Governments are not typically the nimblest customers, so once MSI has proven its systems are reliable and the users have invested in learning the systems, there is much less chance of a new entrant stealing away the business easily. While the commercial customers might generally be more technologically nimble, MSI tries to sell to them on a more consultative basis. In the process, MSI learns valuable operational details about the customer that it can work into its proposed solutions. It is difficult for a competitor to get as full of a picture of the customer's business problems, so it is hard to design as nuanced an offering.
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Long MSI (personally or in accounts where I have trading authority).
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