Monday, 1 February 2016

Secrets of Long-Term Investing Revealed

“........... long-term investing isn’t about having a great system, or a superior analytic intellect, or better access to information, or even the best advice money can buy.  Long-term investing is about character, about depth of vision and the cultivation of patience, about who you are and who you’ve made yourself to be”

What is long-term investing? 
Long-term investing is the process of buying and holding investment securities you believe will compound investor wealth indefinitely into the future.

Why You Need to Become a Long-Term Investor

There are 3 good reasons to become a long-term investor:
  1. It reduces fees
  2. It requires less of your time
  3. It is highly effective

Long-term investing is so successful is because of its beneficial psychological ramifications.  

If you invest for the long-term, you will focus on businesses with strong and durable competitive advantages that have a chance of compounding your wealth for decades, not days.

Long-Term Investing Strategy

The strategy long-term investors follow is straight-forward:
  • Identify companies with durable competitive advantages
  • Be sure these companies are in slow changing industries
  • Invest in these companies when trading at fair or better prices

  • Insurance
  • Health care
  • Food and beverage

To find if a company is trading at ‘fair or better prices’, a few metrics are important.
  • If the company is trading below the market price-to-earnings ratio, its peer’s price-to-earnings ratio, and its 10 year historical average price-to-earnings ratio, it is likely undervalued.  
  • These 3 relative price-to-earnings ratios will help to paint a picture of if a stock is ‘in favor’ or ‘out of favor’.  
As a general rule, it’s best to buy great businesses at a discount – when they are out of favor.

Another good metric to look at for determining value is a company’s expected payback period.
  • Payback period is calculated using an expected growth rate and a stock’s current dividend yield.  
  • The higher the dividend yield and expected growth rate, the lower the payback period.  
  • The payback period is the number of years it will take an investment to pay you back.  
  • Obviously, the lower the payback period, the better.

Long-Term Investing Examples

Warren Buffett’s investment history is perhaps the best example of long-term investments.  Three of his longest running investments are below:
  • Wells Fargo (WFC) – 25% of his portfolio – First purchased in 1989
  • Coca-Cola (KO) – 15% of portfolio – First purchased in 1988
  • American Express (AXP) – 11% of portfolio – First purchased in 1964
All of these three investments are 25 years old or older.

The American Express investment is especially impressive.  Warren Buffett has held American Express for over 50 years!

Stocks for Long-Term Investors

  • Find high quality dividend growth stocks suitable for long-term investors.
  • Identify high quality dividend growth stocks trading at fair or better prices.
  • Have a brief list of blue-chip stocks worthy of long-term investors that are currently trading at fair or better prices.
For example:  One for each sector of the economy is shown:

Long-Term Investing Is Difficult

Long-term investing is not easy.
It is psychologically difficult to hold a stock when its price is declining.
Holding through price declines takes real conviction (remember the marriage analogy?).
The nearly infinite liquidity of the stock market combined with the ease of trading makes selling stocks something you can do on a whim.
But just because you can, doesn’t mean you should.
Stock Market
The constant stream of stock ticker price movements also coerces individual investors into trading unnecessarily.

  • Does it really matter that a stock is up 1% today, or down 0.3% this hour?  
  • Have the long-term prospects of the business really changed?  
Probably not.
To compound these problems even further, the financial media promotes rapid action.

  • To garner views and attention, financial pundits have become LOUD.  
  • They are always promoting the next great stock to buy, or which one MUST be sold.

The Cure:  Watch Dividends, Not Stock Prices

Stock prices lie.

  • They signal a business is in steep decline, when it isn’t.  
  • They say a company is worth 3x as much as it was 3 years ago, when the underlying business has only grown 50%.  
  • Stock prices only represent the perception of other investors.  
  • They do not and cannot show the real total returns an investment will generate.
Benjamin Graham Quote
Instead of watching stock price, avoid them completely.

Look at dividend income instead.

  • Dividend do not lie.  
  • A business simply cannot pay rising dividends for any protracted period of time without the underlying business growing as well.
Dividends are much less volatile than stock prices.

  • Dividends reflect the real earnings power of the business.  
  • As a result, it makes sense to track dividend income rather than stock price movement.  
  • After all, don’t you care what your investment pays you more than what people think about your investment?

The Difference Between Buy & Hold and Long-Term Investing

There is a difference between buy and hold (sometimes called buy and pray) investing and long-term investing.

Buy and hold investing typically means buying and holding no matter what.
That’s not what long-term investing is about.
Sometimes, there is a very good reason to sell a stock.  It just happens much less frequently than most people believe.
Two reasons to sell a stock:
  1. If it cuts or eliminates its dividend payments
  2. If it becomes extremely overvalued
The first reason to sell is intuitive.

  • When a stock cuts its dividend, it violates your reason for investing. 
The second reason to sell is in the case of an extreme overvaluation.

  • I’m not talking about when a stock moves from a price-to-earnings ratio of 15 to 25.  
  • I’m talking about when a stock is trading for a ridiculous price-to-earnings ratio; something like 40+.  
  • An important caveat to remember is to always use adjusted earnings for this calculation.  
  • If a cyclical stock’s earnings temporarily fall from $5.00 per share to $1.00 per share, and the price-to-earnings ratio jumps from 15 to 75, don’t sell.  
  • In this instance, the price-to-earnings ratio is artificially inflated because it is not reflecting the true earnings power of the business.  
Selling due to extreme valuations should only occur very rarely, during extreme bouts of irrational market exuberance.

Final Thoughts

Investing for the long run is simple, but not easy.

It is psychologically difficult.

The amazing success records of investors who believe a long-term outlook is critical for favorable investment returns lends credibility to the idea of long-term investing.
The financial media does not typically discuss the merits of long-term investing because it does not generate fees for the financial industry, and it does not lend itself to flashy headlines or catchy sound bites.
Invest in high quality dividend growth stocks for the long-run.

  • High quality dividend growths stocks with strong competitive advantages offer individual investors the best available mix of current income, growth, and stability as compared to other investment strategies and styles.
Long-term investing requires conviction, perseverance, and the ability to do nothing when others are being very active with their portfolios.

Do you have what it takes to invest for the long run?


1 comment:

John Adam said...

How can I learn how to invest money in stocks?
Financial Planning