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


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

Though the timing of a buy is a whole separate matter, once these types of businesses are bought, it is appropriate to hold them as long as the competitive advantage remains intact and the business is not obviously overvalued (assuming more compelling bargains are not available). Things like an earnings disappointment or a small cyclical glitch do not change the long-term thesis that, over time, the business will continue to eat other companies' lunches.

Even if the initial intent is to buy and hold, there are valid reasons to sell. Sometimes a business with an intact moat can become irrationally overvalued. In his letter to Berkshire Hathaway (NYSE:BRK.A) shareholders in 2004, Buffett hypothesized this might have been the case for Coca-Cola (NYSE:KO) and Gillette (bought by Procter & Gamble (NYSE:PG)) during the late '90s bubble. Other times, the moat itself may begin to degrade (or at least become a little fuzzy). A historically well-run business like Staples (NASDAQ:SPLS) seems to be priced very attractively by many metrics. However, Staples has been noting for a while that online competitors such as Amazon (NASDAQ:AMZN) have been undercutting its prices aggressively. Is this changing industry dynamic the death knell for Staples's moat? Maybe not, but it raises some questions that I would need to answer pretty compellingly in order to buy or continue to hold Staples as a long-term investment. Situations like this can easily become what are termed "value traps": a statistically cheap stock with an underlying business that will continue to struggle, thus leaving the stock at perpetually (nominally) "cheap" prices.

Then there are some businesses which I'm not sure ever had much of a durable competitive advantage. Netflix (NASDAQ:NFLX), the DVD and streaming-movie service, has been on a roller coaster ride over the last few years. I think at the root of this whipsawing has been a debate about Netflix's vulnerability to competitive services and vulnerability to the whims of its content suppliers. Maybe Netflix actually does have a competitive advantage which will stick, but it is too hard for me to tell. In such cases, I simply pass and let the short-term traders play with it. (I realize that the recent quarterly results make my analysis seem asinine. My point is one of investment process, not investment outcome. I just think Netflix's position is too uncertain for me to analyze. If I can't analyze it, what's the difference between such a trade and gambling? Others may have more insight, and may be able to better analyze the situation.)

When the topic of buying and holding an index or an ETF comes up as evidence that buy-and-hold investing doesn't work well, I think this misses the point. Each is composed of good businesses with strong moats and less-competitive businesses with weak moats. If you buy and hold a mishmash of competitive moats, don't be surprised if some of the underlying businesses do really well and some do extremely poorly. On average, your portfolio's competitive advantage will be as mediocre as your investment returns.

So, Doodles, when you think about your next stock purchase, or your financial advisor says that you should hang onto that stock that has lost 50%, ask yourself what the underlying business and its industry will look like in five or 10 years. Will your candidate have taken market share (without killing its profitability) or have sustainably expanded its profit margins? If not, don't fool yourself into thinking it is a candidate for long-term investing. And definitely don't use it as evidence that buy-and-hold investing doesn't work.

Now, if you will excuse me, I am late for a gravy-related event.
Long MSI (personally or in accounts where I have trading authority).
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