November 14, 2010

Buy and hold investing

The idea of buy and hold was popularized in the US by warren buffett, the guru of value investing (and if you have realized, my intellectual guru too).

The idea behind buy and hold has been that one should buy the stocks of the really good companies and hold them for the long term (sometimes over decades) without concerning ourselves with the short term swings in the stock market.

A myth on buy and hold
A few commentators project buy and hold investing as a form of investing requiring no thinking and analysis. All one needs to do is to go ahead and buy an Infosys or a levers or titan at any valuations and just hold onto it. One does not even need to check on the performance of the company, even briefly, on an annual basis.

These commentators point out to investors who made an investment in a levers or Infosys years ago , just sat on their positions and are now comfortably rich. This is
survivorship bias. For every levers or Infosys, there is a company which went bust or went nowhere.

Buy and hold is not brainless investing!!

It requires work, even if there is no activity (read – trading). It may sound easy, but it is not. By the way, why should earning a decent amount of money, while sitting on one’s a**, be easy for everyone?

Why are there no such recommendations?
You may wonder, why one cannot find such recommendations from brokers or analysts. Why don’t they indentify such companies and recommend it to investors?

Let me take a personal example. As far back as 2000, inspite of being a novice, I had a decent amount of conviction that asian paints was a good company (as I had worked with them). I invested a decent sum at that point of time in the stock.

Now lets assume you are my client. Let’s say in 2000, I recommend this stock and you pay me a commission.

You come back next year and we have this conversation

You : So Rohit, what should I do with asian paints?
Me : Nothing. The company’s doing well. Just hold on to it. By the way, you will be getting a bill for my recommendation next month
You (thinking) : What ??!! this dude did nothing for me this year and is charging me. I am not coming back

So I assume you get the point why brokers and tipsters cannot make a living by giving out such buy and hold ideas which can make you rich.

Please note that the advisor is still doing work. He or she has to keep analyzing the company and track how it is doing. The only difference is that as long as the company keeps doing well, there is no need to trade the stock.

The unfortunate reality is that most investors believe some activity is needed to make money and on top of that if an advisor is to be paid, he or she should be ‘doing’ something.

Is it relevant now?
I feel like a dinosaur these days, especially when talking to my friends. The holding time spans range from a few months to a year. If I point out to long term stock ideas, the same friends are quick to point out the fantastic returns they have been able to make in the last 6 months on midcaps and microcaps.

Why wait for the long term when one can get instant gratification :)

The problem with a short term approach, disconnected from an underlying philosophy, is that it works till the going is good. If the market turns south, then the same investors would lose their shirt and all their undergarments and would start singing the buy and hold tune.

An investing philosophy should be based on fundamentals and not on the current fads of the market.

How to practice buy and hold?
I personally do not believe in going and buying a stock blindly and then holding on to it forever (hoping it will do well). I think one should be able to identify on the basis of a reasonable amount of analysis and experience a list of good, long term ideas.

What should be the characteristics of such companies?

A decent operating history – The company should have been in the business over 10 years with an above average record of performance.

Sustainable competitive advantage – The company should have a strong competitive position in the industry so it can sustain its above average performance in the long run

Decent to attractive industry with minimal change – It is important to avoid industries with a lot of change (ex: telecom) or currently in a decline (example – jute). In addition, commodity type industries are also not a great place to find such ideas, though one cannot rule it out.

The hit by truck test – If the unfortunate happens, can you leave the stock untouched in your account as an asset for your family?

The key is to identify a list of such attractive ideas and invest a small amount of money in it (if the valuation are not too high). Once you do that, you need to start following the company and the industry on a regular basis. In time, over a few years, you will become more and more comfortable with the long term prospects of the company.

The idea is not keep adding money as you become more confident of the long term prospects of the company (long term being more than 5 years). One needs to be patient and should let the opportunity come to you. When the market drops due to some short term concern, it is time to add a meaningful amount of money to some of these ideas.

The above approach is not easy. It requires effort and patience. However if you can build a portfolio of 4-5 such companies, you are set for life.

I have been able to identify a few such companies over the last few years. The notable ones are asian paints, Crisil and maybe a Gujarat gas. These names are not set in stone, but are fairly good ones for me.

I am planning to look at new ideas such as titan, HDFC bank, ITC etc and start following them closely. The next time a market crash happens, I plan to load up on these stocks, as I did on Crisil in 2008.

23 comments:

rayhaan said...

hi rohit , nice post.u really pointed out the biggest obstacle in the investor's way - HIS OWN BEHAVIOUR!!!
Really having a funny time analysing unbeloved smallcap stocks , especially those trading at low multiples of freecashflow . QHow are things at ur end?
Q.whats ur opinion on navin fluoride ? (p.s it might have a 'mafatlal hangover' ,just check out the a.r. and u'll understand)
Q.what do u do wen u r not investing, i mean wots ur day job?
P.s it sure looks like u r in luv wid large cap stocks from ur recent stock...:) selection!

Anonymous said...

dear rohit,
to utilise the next market crash , we , the loyal rohit fans, have been on SIP with kotak lt floater fund .because, as they say, market can stay depressedmuch longer than we stay solvent.
AND how good is the geraldine weiss screen for long term hold for blue chip companies- itc was showing on this screener for long time
drmadhupv

Vic said...

Hi Rohit,

Thanks for another solid article.

Yes, would like to know your views/analysis on HDFC bank and titan. Both seem to have all the ingredients for long term portfolio.

Thanks for your clarification on your relationship with Warren Buffet..:-) i.e. "Intellectual" Guru.

Anonymous said...

dear rohit,
how will u keep money ready for that black swan event,when u want to loadup.
do you plan to purchse a small business,because that will really ensure a long term buffett style investing
abhinav

rajsmusings said...

Hi Rohit,

That's a lovely post! And i like the possible outcome of this thought process i.e., an individual investor effectively having to make very few investment choices during his investing lifetime.


I also just read your 2 posts on 'investment journey' written sometime in Aug 2008. They are fabulous! to me it looks like, you are contemplating a slight change in your approach though! am i guessing right ?

I have been thinking on the the topic of buying and holding (probably very long term like 10+ years) for sometime now after reading few books like I.Investor, Poor Charlies Almanack etc... So, here are few points. As an experienced investor you can take them as questions too and reply from your perspective.


1. Will it be good to identify industry/sector players where india has a huge demand/supply gap primarily in B2C category? For example organized Hospital chains is one that comes to my mind.

2. Will it be better for an individual investor to focus only on companies whose product/service he can understand/use at a personal level? I mean take the example of CRISIL, how many of us can claim to understand it's end product/service and can identiy when and if it's doing good/bad as a player in it's own industry ? I hope you are getting the drift of my question. I am mainly talking of being able to analyze a companies performance on the ground before it reflects in it's finances.

I loved your analogy of 'hit by truck test' and i think it's a very important one.

Regards
Raja

Rohit Chauhan said...

hi rayhaan
i am not in love with any cap ..size does not matter to me :)

for a long term portfolio which i would hold for 10+ yrs ..i dont think i would be comfortable with a small cap for that.

for investing below fair value and selling at full value ..small and midcaps are fine.

my day job is of a supply chain consultant

Rohit Chauhan said...

drmadhupv
lol ...on your comment

i have not seen the screen. where can you get that ?

rgds
rohit

Rohit Chauhan said...

Hi vic
i looked at hdfc bank in the past. have to look at titan closely ..will post about it in due course

rgds
rohit

Rohit Chauhan said...

hi abhinav
loading up is subjective ..i am not planning to put 100% of my portfolio in such long term holdings. my post is geared for general investors. if you can invest yourself ..some part can be kept aside for tatical picks too

rgds
rohit

Rohit Chauhan said...

hi raja

you seem to be referring to the peter lynch style of investing. personally i like his approach, but i am not too much of a fan of his 'know the product' style of investing.

how many products can one understand as such ..there are large parts of industry where a common person will never come in contact. it works best only for consumer goods type of companies and there too in a limited sense. also the risk is that one would be looking at a very small sample size - for ex- an investor sees a brand of toothpaste doing well in 10 stores ...does that tell anything ?

i would say absolutely nothing. i have worked in the consumer goods space and a product could be doing great in one state and a complete wash in another. so an individual could be misled by that data alone. to avoid that one has to look at the annual reports which is same as investing in any company without personally knowing the product.

in cases like crisil, key is not the understand the product, but to understand the business model. for ex: crisil is gatekeeper ..any company needing to access debt needs to get rated and crisil will make money no matter what. thats the key to crisil and not really understanding crisil's products

on your other question ..i would personally avoid such new segments such as hospital chains ..i prefer established industries with long established players. it allows one to be sure of the future of the company and hence invest for the long term

sorry - i dont seem to agree with any of your views :)

rgds
rohit

rajsmusings said...

Hi Rohit,

Thanks for your detailed and in depth reply. I haven't yet read much about Peter Lynch though.

I am just sorting out different competing thoughts in my mind and readying my self for times when opportunity will knock again. Your perspective is surely valued high :)

And one point about the hospital chains industry. Don't you think players like Apollo are quite established even in this relatively young industry ?


Regards
Raja

Vic said...

Hi Rohit,

One more question regarding Hinduja Global: you had mentioned in the past that you see some corporate governance issues. Is that perception still hold true? Or not anymore, since you have followed it for a while now.

I recall that you had mentioned similar for Mayur Uni. but I assume you invested and respectively gained from the idea.

I get the feeling that you're not as allergic (:-))to some of these issues as you used to be..let's say few years back.

Would be great help if you can reflect your thoughts on this.

Thanks,

Vikas

Anonymous said...

Dear Rohit

I really like your blog and am in sync with most of your investment strategies.

Have you taken a look at BLIL (Balmer Lawrie Investments Limited) as opposed to BL itself ?

Thanks
Roby

rayhaan said...

hi rohit , q.wots ur opinion on navin fluoride (roce-45%, gross margins-40% ,selling at fcf multiple of 2 ,sales 2 fcf of 3.2 , gud promoter stake and a div. Yield of 4%) wi h possibly very few concerns (just google cool hand luke + navin fluoride and u'll know , really makes me feel i understand wot buffett meant wen he said 'the smarter the journalists, the better off the society')

Anonymous said...

Dear Rohit

According to you what is the intransic value of HDFC bank at present ?

thanks & regards

vinayak

Rohit Chauhan said...

Hi raja
companies like appollo could be good investment ideas. i however do not know enough to comment if these are good for holding for the really long term - which was the point of my post

rgds
rohit

Rohit Chauhan said...

Hi vikas
corporate governance is not a black and white issue always. i have been tracking hinduja global and they seem to be doing a decent job. time will tell if i am wrong on this one

i am still allergic to bad corporate governance ..however i dont have a mind block ..i will follow a company and if the management is not a complete crook ..i am fine with shades of grey

rgds
rohit

Rohit Chauhan said...

hi roby
yes have looked at BLIL in the past ..it is a holding company with additional disount ..i prefer to hold balmer lawrie itself ..however it is almost one and the same till there is a big divestment ..who knows when that will happen

rgds
rohit

Rohit Chauhan said...

rayhaan
will have look ..have never look at the company ..is it a micro cap ?

rgds
rohit

Rohit Chauhan said...

Hi vinayak
last when i looked at hdfc bank i thought it was around 1000 ..must have gone up since then. so it is not cheap by my estimate..i have be wrong on this and may be underestimating the company

rgds
rohit

Vic said...

thanks Rohit for your candid response, appreciate it very much.

Anonymous said...

Thanks Rohit ; noted your feedback on BLIL - I also like Castrol using the same yardstick and would put in a bracket with ITC but below Asian Paints.
Regards
Roby

Rohit Chauhan said...

Hi rayhaan
have you really looked closely at navin flourine ? or you are talking about some other company and i got the name wrong

i scanned through the annual report and it made my stomach churn ...its owned by the mafatlal group and has conflict of interest all over the place

company invested 60 crs in mafatlal industries redeemable cumulative shares and wrote it off
15cr write off on mafatlal denim

in addition they have 31.7 crs still due from that company and are still giving more money as advances and that too to a BIFR company !!

they have loans to a subsidary of 20+ crs and have written off some of it

24 crs loan to sunanda industrial !!

135+ Crs of loans and advances to sister companies !!! these guys are behaving as if they own the company 100%

i dont think i plan to check this company anymore even if they are going to make 100 crs per year ...the shareholder is not going to get anything out of it

rgds
rohit