Buy & Hold Investing? Give It Time

Uploaded on 18 Feb 2009
The Wall Street Journal's Jason Zweig shares his unique perspective on buy and hold investing, concluding that one should look at it differently.


Is buy and hold dead?
I don't think it is right.
That is exactly what people say right before buy and hold comes back to life.  
Nobody says that when the Dow was over 14,000 when buy and holding was a dangerous idea.
They only started saying this when the Dow was nearer 8,000.
But it is cheap now and it is inconceivable that buy and hold is a bad idea at Dow 8,000 than at Dow 14,000.

What about the idea of the market being in a long term bear market that could go on for years, like from 1966 to 1982?
Anytime you buy, it is going to take you years to get back to where you were and people should invest more actively.
We may enter at a protracted period when the returns from the market are below average, that doesn't mean that more active trading in and out of stocks are going to increase your returns.
Though the trading costs are lower now than before, the costs are still real.
If you can buy and hold through a protracted period of low returns, the flip side to this is, you are buying at lower market valuation than before.
People who bought and held from 1966 to 1982, or from 1929 to 1940s and 1950s, did quite well.
It was the people who only held who suffered.
If you are going to retire, you had a big problem.
But if you are younger, buying and holding is a spectacular idea.

But when people said to buy and hold, they do not mean, buy once and then do not put another dime in, and wait for it to go up.
They mean buying steadily, not trying to decide  where you think the bottom has bottomed, but keep buying at lower prices regularly.
Maybe we should not talk about investing.
Instead use the term savings.
If you think of putting money into the financial market in the form of savings, you don't expect to get your returns right away.  
You expect to get it over time and certainly that tricks people up.
Certainly, the returns had been terrible recently and if it is going to pay off, you must give it time.

Burton Malkiel: Timeless Lessons for Investors

1.  Buy and Hold.  Don't time the market

He started his talk by tackling the issue :  "In the light of the 2008 Global Financial Crisis when the market dropped almost 50%, is buy and hold is now dead?"
The best days in the market that gave the best returns were usually the few days that leaped from the bottom of the market.
Don't try to time the market.  It is dangerous.  You can't do it and you will make mistakes.

2.  Dollar Cost Averaging

You make more likely to make more money in a volatile time than a steadily rising market, but this is not always the case.  Of course, if you know the market is going to be steadily rising, you will make more money if you invest a lump sum at the beginning..

3.  Rebalance your portfolio.

He advises rebalancing your portfolio once yearly, example, 60% stock and 40% bond target and rebalancing in January every year.  In a volatile market, rebalancing reduces the volatility and may also increase the return of your portfolio.  In a rising market, rebalancing will reduce the volatiltiy and may reduce the return of your portfolio slightly.

4.  Diversification

In 2008 and early 2009, there were few places to hide.  Many people opined that diversification doesn't work anymore.
Diversification works when the asset classes are not correlated.  Though many asset classes are now more correlated, you can still diversify, example, buying emerging markets and bonds.  How do you access China?  Why not through index funds? (@39 min)

5.  Costs matter

The lower the costs charged by the purveyor of the investment service, the better and the more is left for you.  "You get what you don't pay for!"  Cost you pay is the one thing you can control and you may increase your return by up to 2% per year just by ensuing the cost is low.  He advocates index funds.  Stock market is a zero sum game and costs of mutual funds of >1% shift the distribution of the stock market to that of a negative sum game.  90% of professional managed mutual funds are beaten by the index benchmark.  In his study of mutual funds over many years, less than 5 mutual funds have beaten the market by 2% or more ( @ 29 min).  Buy the index funds.  "It is like searching for the needle in the haystack.  Buy the haystack instead.".
Two-third of bond active managers are beaten by bond-index funds.  His advice is that the core of your portfolio should be in low cost index funds. (You can have more leeway in a satellite portfolio too.)


Q&A:
@ 43 min   Lump sum investing early or Dollar Cost Averaging when you have a big sum of money to invest.
Potential regret of getting into the high of the market.  Reduction in volatility.  Might not always be optimal.  At least some of this big sum of money should still put into the market in dollar cost averaging manner. Can you advise how long to spread this dollar cost averaging?  Depends on the returns from the alternative investments.  Spread your investing over a shorter period now, since the alternative investment return (interest rate)  is low.

@ 48 min.  Missing the 10 best days or missing the 10 worst days.  Some bias in presentation.

@50.30 min.  Corporate governance.

@53 min.  Dividend yield stocks of Warren Buffett.  Buffett is really the needle in the haystack.  Vanguard REIT - a good diversifier.

@1.04.50 min.  How would you invest $1 million?

@1.08.30 min.  What are the target percentages people of various ages should save?  Answer:  MORE.  If you start early, you may have to save a lot due to the compounding effect.  Those who did not save early, probably need to save a lot more to catch up (20% or more).  The opportunity cost of not saving $1 in your 20s might be $10 or $15 when you are in your 50s.






Uploaded on 1 Jun 2010
Dr. Burton G. Malkiel, the Chemical Bank Chairman's Professor of Economics at Princeton University, is the author of the widely read investment book, A Random Walk Down Wall Street. He has also authored several other books, including the recently published The Elements of Investing.

Dr. Malkiel has long held professorships in economics at Princeton, where he was also chairman of the Economics Department. He also served as the dean of the Yale School of Management and William S. Beinecke Professor of Management Studies. Dr. Malkiel is a past president of the American Finance Association and the International Atlantic Economic Association, and a past appointee to the President's Council of Economic Advisors. He continues to serve on several corporate and investment management boards.

Intrinsic value of Great Businesses: What's the business actually worth? Think long-term.

Company OPX

52 week high:  $52.99  (April 2010)  Market cap $960 million
52 week low:  $33.33 (July 2010)  Market cap $ 625 million
Variance:  35.2%


1.  Is the market really suggesting that this business was worth $960 million in April 2010, but only $625 million the following July?

2.  Yes, this is exactly what the market is suggesting.

3.  What's the business actually worth?

4.  Because it ought to be obvious that a fast-growing company cannot be worth $625 million and $960 million at roughly the same time.  

5.  Our goal as investor is to buy $960 million businesses when the market's charging $625 million.
6.  If you think these things don't happen, be assured:  They happen all the time.

7.  It is even better when we can buy a $500 million business for $300 million and watch the company grow into a $3 billion business.  

8.  It is this effect - the fact that great businesses make themselves more valuable over time - that keeps us from selling a $500 million business when its market cap increases to $600 million.

9.  After all, the $500 million valuation is based on our own analysis, and mathematically speaking, it's our single point of highest confidence in a range of values we believe the company could be worth.

10.  It might be substantially more.  

11.  If you're disciplined enough to only buy companies when they are priced at the low end of your range of potential values, your returns over time are almost guaranteed to satisfy.

12.  Holding a company when it's in the higher end of your range of values leaves you somewhat susceptible to a stock drop, given the lower margin of safety.  

13.  But if you have properly identified the company as a superior generator of wealth, the biggest mistake you might ever make is selling it because its shares are a few dollars too high.

14.  If you bough company OPX back in December 1987, for example, your shares rose 75%, from $23 to $40 in about two months.

15.  That's great return - but over the next 20 years, the stock has risen another seven times in value - tax free.

16.  Ultimately, it is nearly impossible to manage superior long-term results by focusing on short-term aims.

17.  Company OPX has evolved from a regional small cap into one of the most important retailers in the world, generating spectacular returns for shareholders in the process.

The Value Investor's Handbook

March 20 2011 

Value investing, and any type of investing for that matter, varies in execution with each person. There are, however, some general principles that are shared by all value investors. These principles have been spelled out by famed investors like Peter Lynch, Kenneth Fisher, Warren Buffet, John Templeton and many others. In this article, we will look at these principles in the form of a value investor's handbook.

Tutorial: The World's Greatest Investors

Buy BusinessesIf there is one thing that all value investors can agree on, it's that investors should buy businesses, not stocks. This means ignoring trends in stock prices and other market noise. Instead, investors should look at the fundamentals of the company that the stock represents. Investors can make money following trending stocks, but it involves a lot more activity than value investing. Searching for good businesses selling at a good price based on probable future performance requires a larger time commitment for research, but the payoffs include less time spent buying and selling and fewer commission payments. (False signals can drown out underlying trends. Find out how to tone them down and tune them out in Trading Without Noise.)

Love the Business You BuyYou wouldn't pick a spouse based solely on his or her shoes, and you shouldn't pick a stock based on cursory research. You have to love the business you are buying, and that means being passionate about knowing everything about that company. You need to strip the attractive covering from a company's financials and get down to the naked truth. Many companies look far better when you judge them on basic price to earnings (P/E), price to book (P/B) and earnings per share (EPS) ratios than they do when you look into the quality of the numbers that make up those figures.

If you keep your standards high and make sure the company's financials look as good naked as they do dressed up, you're much more likely to keep it in your portfolio for a long time. If things change, you'll notice it early. If you like the business you buy, paying attention to its ongoing trials and successes becomes more of a hobby than a chore.

Simple Is BestIf you don't understand what a company does or how, then you probably shouldn't be buying shares. Critics of value investing like to focus on this main limitation. You are stuck looking for businesses that you can easily understand because you have to be able to make an educated guess about the future earnings of the business. The more complex a business is, the more uncertain your projections will necessarily be. This moves the emphasis from "educated" to "guess."

You can buy businesses you like but don't completely understand, but you have to factor in uncertainty as added risk. Any time a value investor has to factor in more risk, he has to look for a larger margin of safety - that is, more of a discount from the calculated true value of the company. There can be no margin of safety if the company is already trading at many multiples of its earnings, which is a strong sign that, however exciting and new the idea is, the business is not a value play. Simple businesses also have an advantage, as it's harder for incompetent management to hurt the company. (For a complete guide to reading the financial reports, check out our Financial Statements Tutorial.)

Look for Owners, Not Managers

Management can make a huge difference in a company. Good management adds value beyond a company's hard assets. Bad management can destroy even the most solid financials. There have been investors who have based their entire investing strategies on finding managers that are honest and able. To quote Buffett, "look for three qualities: integrity, intelligence, and energy. And if they don't have the first, the other two will kill you." You can get a sense of management's honesty through reading several years' worth of financials. How well did they deliver on past promises? If they failed, did they take responsibility, or gloss it over? (Find out more about Buffett's investing in Warren Buffett: How He Does It.)

Value investors want managers who act like owners. The best managers ignore the market value of the company and focus on growing the business, thus creating long-term shareholder value. Managers who act like employees often focus on short-term earnings in order to secure a bonus or other performance perk, sometimes to the long-term detriment of the company. Again, there are many ways to judge this, but the size and reporting of compensation is often a dead give away. If you're thinking like an owner, you pay yourself a reasonable wage and depend on gains in your stock holdings for a bonus. At the very least, you want a company that expenses its stock options. (Still wondering how to investigate the top brass? Check out Evaluating A Company's Management.)

When You Find a Good Thing, Buy a LotOne of the areas where value investing runs contrary to commonly accepted investing principles is on the issue of diversification. There are long stretches where a value investor will be idle. This is because of the exacting standards of value investing as well as overall market forces. Toward the end of a bull market, everything gets expensive, even the dogs, so a value investor may have to sit on the sidelines waiting for the inevitable correction. Time, an important factor in compounding, is lost while waiting, so when you do find undervalued stocks, you should buy as much as you can. Be warned, this will lead to a portfolio that is high-risk according to traditional measures like beta. Investors are encouraged to avoid concentrating on only a few stocks, but value investors generally feel that they can only keep proper track of a few stocks at a time.

One obvious exception is Peter Lynch, who kept almost all of his funds in stocks at all times. Lynch broke stocks into categories and then cycled his funds through companies in each category. He also spent upwards of 12 hours every day checking and rechecking the many stocks held by his fund. As an individual value investor with a different day job, however, it's better to go with a few stocks for which you've done the homework and feel good about holding long term. (Learn the basic tenets that helped this famous investor earn his fortune in Pick Stocks Like Peter Lynch.)

Measure Against Your Best InvestmentAnytime you have more investment capital, your aim for investing should not be diversity, but finding an investment that is better than the ones you already own. If the opportunities don't beat what you already have in your portfolio, you may as well buy more of the companies you know and love, or simply wait for better times. During idle times, a value investor can identify the stocks he or she wants and the price at which they'll be worth buying. By keeping a wish list like this, you'll be able to make decisions quickly in a correction.

Ignore the Market 99% of the TimeThe market only matters when you enter or exit a position; the rest of the time, it should be ignored. If you approach buying stocks like buying a business, you'll want to hold onto them as long as the fundamentals are strong. During the time you hold an investment, there will be spots where you could sell for a large profit and others were you're holding an unrealized loss. This is the nature of marketvolatility.

The reasons for selling a stock are numerous, but a value investor should be as slow to sell as he or she is to buy. When you sell an investment, you expose your portfolio to capital gains and usually have to sell a loser to balance it out. Both of these sales come with transaction costs that make the loss deeper and the gain smaller. By holding investments with unrealized gains for a long time, you forestall capital gains on your portfolio. The longer you avoid capital gains and transaction costs, the more you benefit from compounding. (Find out how your profits are taxed and what to consider when making investment decisions in Tax Effects On Capital Gains.)

The Bottom LineValue investing is a strange mix of common sense and contrarian thinking. While most investors can agree that a detailed examination of a company is important, the idea of sitting out on a bull market goes against the grain. It's undeniable that funds held constantly in the market have outperformed cash held outside the market, waiting for a down market. This is a fact, but a deceiving one. The data is derived from following the performance of indexes like the S&P 500 over a number of years. This is where passive investing and value investing get confused.

In both types of investing, the investor avoids unnecessary trading and has a long-term holding period. The difference is that passive investing relies on average returns from an index fund or other diversified instrument. A value investor seeks out above-average companies and invests in them. Therefore, the probable range of return for value investing is much higher. In other words, if you want the average performance of the market, you're better off buying an index fund right now and piling money into it over time. If you want to outperform the market, however, you need a concentrated portfolio of outstanding companies. When you find them, the superior compounding will make up for the time you spent waiting in a cash position. Value investing demands a lot of discipline on the part of the investor, but in return offers a large potential payoff. (Looking for a little more information on index investing, see the Index Investing Tutorial.) 

http://www.investopedia.com/articles/fundamental-analysis/09/value-investing.asp

What Is Warren Buffett's Investing Style?

May 23 2011

If you want to emulate a classic value style, Warren Buffett is a great role model. Early in his career, Buffett said, "I'm 85% Benjamin Graham." Graham is the godfather of value investing and introduced the idea of intrinsic value - the underlying fair value of a stock based on its future earnings power. But there are a few things worth noting about Buffett's interpretation of value investing that may surprise you. (For more on Warren Buffett and his current holdings, check out Coattail Investor.)

TUTORIAL: Stock Picking Strategies

First, like many successful formulas, Buffett's looks simple. But simple does not mean easy. To guide him in his decisions, Buffett uses 12 investing tenets, or key considerations, which are categorized in the areas of business, management, financial measures and value (see detailed explanations below). Buffett's tenets may sound cliché and easy to understand, but they can be very difficult to execute. For example, one tenet asks if management is candid with shareholders. This is simple to ask and simple to understand, but it is not easy to answer. Conversely, there are interesting examples of the reverse: concepts that appear complex yet are easy to execute, such as economic value added (EVA). The full calculation of EVA is not easy to comprehend, and the explanation of EVA tends to be complex. But once you understand that EVA is a laundry list of adjustments - and once armed with the formula - it is fairly easy to calculate EVA for any company.

Second, the Buffett "way" can be viewed as a core, traditional style of investing that is open to adaptation. Even Hagstrom, who is a practicing Buffett disciple, or "Buffettologist," modified his own approach along the way to include technology stocks, a category Buffett conspicuously continues to avoid. One of the compelling aspects of Buffettology is its flexibility alongside its phenomenal success. If it were a religion, it would not be dogmatic but instead self-reflective and adaptive to the times. This is a good thing. Day traders may require rigid discipline and adherence to a formula (for example, as a means of controlling emotions), but it can be argued that successful investors ought to be willing to adapt their mental models to current environments. (It's not always bad to copy someone, especially when it's one of the greatest investors ever. Check out Emulate Buffett For Fun And Profit - Mostly Profit.)

Business
Buffett adamantly restricts himself to his "circle of competence" - businesses he can understand and analyze. As Hagstrom writes, investment success is not a matter of how much you know but rather how realistically you define what you don't know. Buffett considers this deep understanding of the operating business to be a prerequisite for a viable forecast of future business performance. After all, if you don't understand the business, how can you project performance? Buffett's business tenets each support the goal of producing a robust projection. First, analyze the business, not the market or the economy or investor sentiment. Next, look for a consistent operating history. Finally, use that data to ascertain whether the business has favorable long-term prospects.

Management
Buffett's three management tenets help evaluate management quality. This is perhaps the most difficult analytical task for an investor. Buffett asks, "Is management rational?" Specifically, is management wise when it comes to reinvesting (retaining) earnings or returning profits to shareholders as dividends? This is a profound question, because most research suggests that historically, as a group and on average, management tends to be greedy and retain a bit too much (profits), as it is naturally inclined to build empires and seek scale rather than utilize cash flow in a manner that would maximize shareholder value. Another tenet examines management's honesty with shareholders. That is, does it admit mistakes? Lastly, does management resist the institutional imperative? This tenet seeks out management teams that resist a "lust for activity" and the lemming-like duplication of competitor strategies and tactics. It is particularly worth savoring because it requires you to draw a fine line between many parameters (for example, between blind duplication of competitor strategy and outmaneuvering a company that is first to market).

Financial Measures 

Buffett focuses on return on equity (ROE) rather than on earnings per share. Most finance students understand that ROE can be distorted by leverage (a debt-to-equity ratio) and therefore is theoretically inferior to some degree to the return-on-capital metric. Here, return-on-capital is more like return on assets (ROA) or return on capital employed (ROCE), where the numerator equals earnings produced for all capital providers and the denominator includes debt and equity contributed to the business. Buffett understands this, of course, but instead examines leverage separately, preferring low-leverage companies. He also looks for high profit margins.

His final two financial tenets share a theoretical foundation with EVA. First, Buffett looks at what he calls "owner's earnings," which is essentially cash flow available to shareholders, or technically, free cash flow to equity (FCFE). Buffett defines it as net income plus depreciation and amortization (for example, adding back non-cash charges) minus capital expenditures (CAPX) minus additional working capital (W/C) needs. In summary, net income + D&A - CAPX - (change in W/C). Purists will argue the specific adjustments, but this equation is close enough to EVA before you deduct an equity charge for shareholders. Ultimately, with owners' earnings, Buffett looks at a company's ability to generate cash for shareholders, who are the residual owners.

Buffett also has a "one-dollar premise," which is based on the question: What is the market value of a dollar assigned to each dollar of retained earnings? This measure bears a strong resemblance tomarket value added (MVA), the ratio of market value to invested capital.

Value
Here, Buffett seeks to estimate a company's intrinsic value. A colleague summarized this well-regarded process as "bond math." Buffett projects the future owner's earnings, then discounts them back to the present. Keep in mind that if you've applied Buffett's other tenets, the projection of future earnings is, by definition, easier to do, because consistent historical earnings are easier to forecast.

Buffett also coined the term "moat," which has subsequently resurfaced in Morningstar's successful habit of favoring companies with a "wide economic moat." The moat is the "something that gives a company a clear advantage over others and protects it against incursions from the competition." In a bit of theoretical heresy perhaps available only to Buffett himself, he discounts projected earnings at the risk-free rate, claiming that the "margin of safety" in carefully applying his other tenets presupposes the minimization, if not the virtual elimination, of risk.

The Bottom Line
In essence, Buffett's tenets constitute a foundation in value investing, which may be open to adaptation and reinterpretation going forward. It is an open question as to the extent to which these tenets require modification in light of a future where consistent operating histories are harder to find, intangibles play a greater role in franchise value and the blurring of industries' boundaries makes deep business analysis more difficult. (If you appreciate the fundamentals of value investing, you'll want to study this: The Value Investor's Handbook.)

http://www.investopedia.com/articles/05/012705.asp

Warren Buffett's Bear Market Maneuvers

July 12 2009

In times of economic decline, many investors ask themselves, "What strategies does the Oracle of Omaha employ to keep Berkshire Hathaway on target?" The answer is that the esteemed Warren Buffett, the most successful known investor of all time, rarely changes his long-term value investment strategy and regards down markets as an opportunity to buy good companies at reasonable prices. In this article, we will cover the Buffett investment philosophy and stock-selection criteria with specific emphasis on their application in a down market and a slowing economy. (For more on Warren Buffett and his current holdings, sign up for our Coattail Investor newsletter.)

The Buffett Investment Philosophy

Buffett has a set of definitive assumptions about what constitutes a "good investment". These focus on the quality of the business rather than the short-term or near-future share price or market moves. He takes a long-term, large scale, business value-based investment approach that concentrates on good fundamentals and intrinsic business value, rather than the share price. (For further reading, seeWarren Buffett: The Road To Riches and What Is Warren Buffett's Investing Style?)

Buffett looks for businesses with "a durable competitive advantage." What he means by this is that the company has a market position, market share, branding or other long-lasting edge over its competitors that either prevents easy access by competitors or controls a scarce raw-material source. (For more insight, see Competitive Advantage Counts, 3 Secrets Of Successful Companiesand Economic Moats Keep Competitors At Bay.)

Buffett employs a selective contrarian investment strategy: using his investment criteria to identify and select good companies, he can then make large investments (millions of shares) when the market and the share price are depressed and when other investors may be selling.

In addition, he assumes the following points to be true:

• The global economy is complex and unpredictable.
• The economy and the stock market do not move in sync.
• The market discount mechanism moves instantly to incorporate news into the share price.
• The returns of long-term equities cannot be matched anywhere else.

Buffett Investment Activity

Berkshire Hathaway investment industries over the years have included:

• Insurance 
• Soft drinks 
• Private jet aircraft
• Chocolates 
• Shoes
• Jewelry 
• Publishing
• Furniture 
• Steel
• Energy 
• Home building

The industries listed above vary widely, so what are the common criteria used to separate the good investments from the bad?

Buffett Investment Criteria

Berkshire Hathaway relies on an extensive research-and-analysis team that goes through reams of data to guide their investment decisions. While all the details of the specific techniques used are not made public, the following 10 requirements are all common among Berkshire Hathaway investments:

1. The candidate company has to be in a good and growing economy or industry.
2. It must enjoy a consumer monopoly or have a loyalty-commanding brand.
3. It cannot be vulnerable to competition from anyone with abundant resources.
4. Its earnings have to be on an upward trend with good and consistent profit margins.
5. The company must enjoy a low debt/equity ratio or a high earnings/debt ratio.
6. It must have high and consistent returns on invested capital.
7. The company must have a history of retaining earnings for growth.
8. It cannot have high maintenance costs of operations, high capital expenditure or investment cash flow.
9. The company must demonstrate a history of reinvesting earnings in good business opportunities, and its management needs a good track record of profiting from these investments.
10. The company must be free to adjust prices for inflation.

The Buffett Investment Strategy

Buffett makes concentrated purchases. In a downturn, he buys millions of shares of solid businesses at reasonable prices. Buffett does not buy tech shares because he doesn't understand their business or industry; during the dotcom boom, he avoided investing in tech companies because he felt they hadn't been around long enough to provide sufficient performance history for his purposes.

And even in a bear market, although Buffett had billions of dollars in cash to make investments, in his 2009 letter to Berkshire Hathaway shareholders, he declared that cash held beyond the bottom would be eroded by inflation in the recovery.

Buffett deals only with large companies because he needs to make massive investments to garner the returns required to post excellent results for the huge size to which his company, Berkshire Hathaway, has grown. (To learn about the disadvantage of being confined to blue chip stocks, readWhy Warren Buffett Envies You.)

Buffett's selective contrarian style in a bear market includes making some large investments in blue chip stocks when their stock price is very low. And Buffett might get an even better deal than the average investor: His ability to supply billions of dollars in cash infusion investments earns him special conditions and opportunities not available to others. His investments often are in a class of secured stock with its dividends assured and future stock warrants available at below-market prices.

Conclusion

Buffett's strategy for coping with a down market is to approach it as an opportunity to buy good companies at reasonable prices. Buffett has developed an investment model that has worked for him and the Berkshire Hathaway shareholders over a long period of time. His investment strategy is long term and selective, incorporating a stringent set of requirements prior to an investment decision being made. Buffett also benefits from a huge cash "war chest" that can be used to buy millions of shares at a time, providing an ever-ready opportunity to earn huge returns.

http://www.investopedia.com/articles/stocks/09/buffett-bear-market-strategies.asp?utm_source=coattail-buffett&utm_medium=Email&utm_campaign=WBW-6/12/2013-b

Berkshire Hathaway's Acquisition Criteria: Telling it like it is.

Berkshire Hathaway's Acquisition Criteria: Telling it like it is

Take a look at the following set of "acquisition criteria," straight from the 2006 Berkshire Hathaway Annual report. Straight, clear, to the point - and never before have we seen anything like this - including the commentary - in a shareholder report.

ACQUISITION CRITERIA

We are eager to hear from principals or their representatives about businesses that meet all of the following criteria:

1. Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units).
2. Demonstrated consistent earning power (future projections are of no interest to us, nor are "turnaround" situations).
3. Businesses earning good returns on equity while employing little or no debt.
4. Management in place (we can't supply it).
5. Simple businesses (if there's lots of technology, we won't understand it).
6. An offering price (we don't want to waste our time or that of the seller by talking, even preliminary, about a transaction when price is unknown).

The larger the company, the greater will be our interest. We would like to make an acquisition in the $5-20 billion range. We are not interested, however, in receiving suggestions about purchases we may make in the general stock market.

We will not engage in unfriendly takeovers. We can promise complete confidentiality and a very fast answer - customarily within five minutes - as to whether we're interested. We prefer to buy for cash, but will consider issuing stock when we receive as much in intrinsic business value as we give. We don't participate in auctions.

Deterioration on those key fundamentals may lead you to sell, but do you also sell on valuation?

Kinnel: On the sell-side, deterioration on those key fundamentals may lead you to sell, but do you also sell on valuation?

Akre: So, in response to your first observation, deterioration to any one of those three will certainly cause us to re-evaluate it. It won't automatically cause us to sell, but it will certainly cause us to re-evaluate it. Our notion is that if we don't get those three legs right where there develop differently in the future than they have in the past, theoretically our loss is the time value of money that it hasn't always been the case. But the deterioration of one of those legs or more than one of those legs diminishes the value of that compounding and, indeed, is likely to cause us to change our view. That's number one.

Number two, the issue of selling on valuation is way more difficult for us. And what we've said is that from a matter of life experience, if I have a stock that's at $40 and I think it's way too richly valued and I sell it with a goal of buying it back at $25, my life experience is it trades to $25.01 or trades through $25 and back up and it trades 200 shares there.   The next time I look at it, it's $300, and I've missed the opportunity. It's my way of saying that the really good ones are too hard to find.  

If I have one of these great compounders, I'm likely to continue to own it through thick and thin knowing that periodically, it's likely to be undervalued and periodically likely to be overvalued. The things that cause us to sell when one or more of the legs of the stool deteriorates. Occasionally, on a valuation basis, maybe we'll take some money off the table.

Lastly, if we're trying to continue to maintain a very focused portfolio, if we run across things that we think are simply better choices, then we maymake changes based on that. 

Buy-and-Hold is Dead .... Long Live Buy-and-Hold

To be an iconoclast is the quick route to raise one's profile. Devise a novel theory, toss in a few data-mined graphs to support a point and then stand back and watch accolades flow in.   

 In recent years, buy-and-hold has suffered its share of slings and arrows by those with novel theories. Just cobble together the right array of market-timing indicators and any investor can put buy-and-hold to shame, so the detractors sneer. 

As an income investor, I bristle at the impertinence, because timing the market is far, far more difficult than the data-mined graphs lead you to believe. Sure, if you could go back in time, you could time your purchases and sells to perfection.

Unfortunately, the same luxury doesn't exist going forward - never has and never will. 

I'm an income investor. I'm also a buy-and-hold investor. My focus is to buy and then hold aninvestment over time – measured in years, in most cases.  I approach an investment as an investment. And an investment, like a garden, requires time to bear fruit. 

Don't misunderstand. I'm not denigrating market-timing traders; they serve a worthwhile function, not the least of which is as liquidity providers. It's just that trading isn't my bailiwick. I prefer to build wealth over time by investing in cash-generating assets. It's no coincidence, therefore, that theHigh Yield Wealth portfolio is a low-turnover portfolio. 

 Buy-and-hold might be antiquated, but it's hardly inferior. Buy-and-hold instills a number of advantages, especially for income investors. 

Taxes are an obvious advantage. Hold an investment longer than a year and the tax rate on a subsequent sale drops to the capital gains rate of 15% for most investors. Sell within a year and gains are taxed at the higher marginal income tax rate. 

Qualified dividends – those paid by most corporations – are also taxed at the 15% rate for most investors. But there’s a catch: You must hold the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. Trade within that period and you'll incur a higher tax liability.  

That said, the potential to compound wealth is the most appealing aspect of buy-and-hold. 

I've written frequently on the wonders of dividend-growth investing. But to maximize the wonders, you have to extend your holding period to years, if not decades. 

 Altria (MO) , the maker of Marlboro cigarettes, is underscores the power of buy-and-hold when combined with dividend growth.

Altria has paid a dividend for decades, and has raised that dividend faithfully and annually for the past 45 years. Rising dividends, in turn, have reliably powered Altria's share price higher. 

 In 2005, Wharton School finance professor Jeremy Siegel wrote an insightful essay titled “Ben Bernanke's Favorite Stock.” That stock was Altria.  Siegel wrote that from 1957 - when the S&P 500 Index was founded - to 2005, Altria produced an average 20% return annually, handily beating the other 499 members of the index.

The record continues to this day, and I can bear witness firsthand. Since Altria was added to theHigh Yield Wealth portfolio in March 2012, it has produced a 43% total return, which runs well ahead of the 20% historically average annual return Siegel refers to. 

 The return generated by Altria in High Yield Wealth isn't predicated on reinvesting dividends, though Siegel's example is.

 By reinvesting Altria's dividends into shares, investors have been able to generate exceptional return over the years, due in large part to those times when Altria came under government attack or new regulation, which invariable lowered the share price. Altria investors were the beneficiary of a continually rising dividend, which could then be used to purchase lower-priced shares, which always recovered.

 Altria's extraordinary long-term wealth creation simply couldn't have been replicated in a trading strategy. An investor had to have bought and then held through thick and thin over many years. 

So don't believe the detractors. Buy-and-hold isn't dead. It's alive and well, and benefiting many investors with the patience and skill to employ it. I know, because I'm one of them.

More From Wyatt Investment Research 

• Stocks Slow, but IPO Market Chugs Along
• Double Your Income on the World's Best Dividend Stocks
• When to sell a dividend stock

Warren Buffett's Bear Market Maneuvers

In times of economic decline, many investors ask themselves, "What strategies does the Oracle of Omaha employ to keep Berkshire Hathaway on target?" The answer is that the esteemed Warren Buffett, the most successful known investor of all time, rarely changes his long-term value investment strategy and regards down markets as an opportunity to buy good companies at reasonable prices. In this article, we will cover the Buffett investment philosophy and stock-selection criteria with specific emphasis on their application in a down market and a slowing economy. (For more on Warren Buffett and his current holdings, sign up for our Coattail Investor newsletter.)

The Buffett Investment PhilosophyBuffett has a set of definitive assumptions about what constitutes a "good investment". These focus on the quality of the business rather than the short-term or near-future share price or market moves. He takes a long-term, large scale, business value-based investment approach that concentrates on good fundamentals and intrinsic business value, rather than the share price. (For further reading, see Warren Buffett: The Road To Riches and What Is Warren Buffett's Investing Style?)

Buffett looks for businesses with "a durable competitive advantage." What he means by this is that the company has a market position, market share, branding or other long-lasting edge over its competitors that either prevents easy access by competitors or controls a scarce raw-material source. (For more insight, see Competitive Advantage Counts, 3 Secrets Of Successful Companiesand Economic Moats Keep Competitors At Bay.)

Buffett employs a selective contrarian investment strategy: using his investment criteria to identify and select good companies, he can then make large investments (millions of shares) when the market and the share price are depressed and when other investors may be selling.

In addition, he assumes the following points to be true:

• The global economy is complex and unpredictable.
• The economy and the stock market do not move in sync.
• The market discount mechanism moves instantly to incorporate news into the share price.
• The returns of long-term equities cannot be matched anywhere else.

Buffett Investment ActivityBerkshire Hathaway investment industries over the years have included:

• Insurance 
• Soft drinks 
• Private jet aircraft
• Chocolates 
• Shoes
• Jewelry 
• Publishing
• Furniture 
• Steel
• Energy 
• Home building

The industries listed above vary widely, so what are the common criteria used to separate the good investments from the bad?

Buffett Investment Criteria

Berkshire Hathaway relies on an extensive research-and-analysis team that goes through reams of data to guide their investment decisions. While all the details of the specific techniques used are not made public, the following 10 requirements are all common among Berkshire Hathaway investments:

1. The candidate company has to be in a good and growing economy or industry.
2. It must enjoy a consumer monopoly or have a loyalty-commanding brand.
3. It cannot be vulnerable to competition from anyone with abundant resources.
4. Its earnings have to be on an upward trend with good and consistent profit margins.
5. The company must enjoy a low debt/equity ratio or a high earnings/debt ratio.
6. It must have high and consistent returns on invested capital.
7. The company must have a history of retaining earnings for growth.
8. It cannot have high maintenance costs of operations, high capital expenditure or investment cash flow.
9. The company must demonstrate a history of reinvesting earnings in good business opportunities, and its management needs a good track record of profiting from these investments.
10. The company must be free to adjust prices for inflation.

The Buffett Investment StrategyBuffett makes concentrated purchases. In a downturn, he buys millions of shares of solid businesses at reasonable prices. Buffett does not buy tech shares because he doesn't understand their business or industry; during the dotcom boom, he avoided investing in tech companies because he felt they hadn't been around long enough to provide sufficient performance history for his purposes.

And even in a bear market, although Buffett had billions of dollars in cash to make investments, in his 2009 letter to Berkshire Hathaway shareholders, he declared that cash held beyond the bottom would be eroded by inflation in the recovery.

Buffett deals only with large companies because he needs to make massive investments to garner the returns required to post excellent results for the huge size to which his company, Berkshire Hathaway, has grown. (To learn about the disadvantage of being confined to blue chip stocks, readWhy Warren Buffett Envies You.)

Buffett's selective contrarian style in a bear market includes making some large investments in blue chip stocks when their stock price is very low. And Buffett might get an even better deal than the average investor: His ability to supply billions of dollars in cash infusion investments earns him special conditions and opportunities not available to others. His investments often are in a class of secured stock with its dividends assured and future stock warrants available at below-market prices.

ConclusionBuffett's strategy for coping with a down market is to approach it as an opportunity to buy good companies at reasonable prices. Buffett has developed an investment model that has worked for him and the Berkshire Hathaway shareholders over a long period of time. His investment strategy is long term and selective, incorporating a stringent set of requirements prior to an investment decision being made. Buffett also benefits from a huge cash "war chest" that can be used to buy millions of shares at a time, providing an ever-ready opportunity to earn huge returns.

For further reading, see Think Like Warren Buffett and Warren Buffett's Best Buys.

July 12 2009

http://www.investopedia.com/articles/stocks/09/buffett-bear-market-strategies.asp?utm_source=coattail-buffett&utm_medium=Email&utm_campaign=WBW-6/12/2013-b

Related Articles

1. What Is Warren Buffett's Investing Style?

2. Warren Buffett: How He Does It

3. Warren Buffett: The Road To Riches

4. Economic Indicators That Do-It-Yourself Investors Should Know

5. Introduction To The Portfolio Dedicated Strategy

Buy and Hold is safe and rewarding for selected stocks

Have a look at this portfolio.
Note that dividend gains are not included in the calculations.

https://docs.google.com/spreadsheet/ccc?key=0AuRRzs61sKqRdDFQd2QtdjZtNjBtUjlMUWtvaUowNlE

Uncle Chua's Buy and Hold Portfolio Performance Update

I have written about Uncle Chua's story and how he accumulated a great deal of wealth through his stock investment in Singapore.  The portfolio of stocks that he left in his will was mentioned in a book.

Here is Uncle Chua's portfolio & dividend income, reproduced here as accurately as was depicted in the book:
Uncle Chua's portfolio 2001
http://spreadsheets.google.com/pub?key=r5DhwS2nWTiIAK0pDCIPD-Q

All the shares he dealt in were ALL blue chip stocks.

I thought it would be interesting to see how his portfolio of stocks might have performed up to today, assuming the portfolio was left unmanaged, essentially a buy and hold strategy.

It was difficult to determine the initial prices of some of the stocks in the year 2001 and I have used the earliest available stock prices, from the Yahoo Finance website, to represent these initial prices of the stocks in 2001.  Some initial prices were left blank as I could not get any information on these.

Well, let's have a look at his updated portfolio.

Click here:
Uncle Chua's Updated portfolio 2012
https://docs.google.com/spreadsheet/ccc?key=0AuRRzs61sKqRdG43MlFBeWVDWVVpaDFBeHZxY181U1E

Uncle Chua's portfolio (Update)

Performance (not including dividends)
From 2001 to 2012
Period of 11 years		Gain %
		215.6%
		CAGR
		11.0%

What conclusions can we derive from Uncle Chua's updated portfolio?

The portfolio has done quite well, returning a CAGR in share appreciation of  11.0%.  With dividends added, its performance has certainly outperformed the general market.  Do you agree?

The buy and hold strategy for this portfolio can be adopted by the defensive investors in their investing.

There are great lessons one can derive from Uncle Chua's legacy even today.

Conclusion:   Buy and hold is a safe and rewarding strategy for highly selected stocks.  



Related:

Uncle Chua's Portfolio & Dividend Income

http://myinvestingnotes.blogspot.com/2009/05/uncle-chuas-portfolio-dividend-income.html

The story of Uncle Chua

http://myinvestingnotes.blogspot.com/2009/05/story-of-uncle-chua.html


Appendix:   Rule Of Five 

The Rule of Five is BetterInvesting's method of letting you know you're not perfect and neither are your stock selections.

It states "For every five stocks you select using BetterInvesting methods, one will do much better than you expected, three will do about as well as you expected, and one will do much worse than you expected." 



The Rule of Five forms the basis for the first step of portfolio management, defense.

Here are the three possible outcomes for a stock's fundamentals on the SSG.



Defensive portfolio management's ONLY concern is finding stocks whose FUNDAMENTALS of SALES, PRE-TAX PROFITS, EPS, & PRE-TAX PROFIT MARGIN are not meeting your projections for future quality.

Click here  for a more indepth discussion of defensive portfolio management or click here   to see how the PERT Report is used to implement defensive portfolio management.

The Truth About Stocks for the Long Run

By Alex Dumortier, CFA September 19, 2012

Don't get me wrong. I'm convinced that equities are an appropriate and important component of a long-term strategy to build wealth. However, there are a certain number of popular myths regarding stocks that have taken hold and that can be potentially dangerous to your financial well-being. In this article, I'm highlighting two of them.

Myth 1: Stocks' expected return is 10% to 11% annually
I have seen financial writers and professional investors cite this range (or a figure contained in this range) for the historical average return for stocks innumerable times. That's fine, in principle; the trouble is that they often imply or even assert openly that this is a sound basis for future expected returns.

As far as I can tell, the source for this range may be Long-Run Stock Returns: Participating in the Real Economy (2003), in which Roger Ibbotson of Yale University and his co-author Peng Chen calculate that stocks produced an average return of 10.70% during the period 1926-2000. That's a historical observation (anomaly?) and investors should absolutely not anchor on it when they think about future returns.

That specific period was atypical in a way that can be dangerously misleading if you don't look beyond the "headline" number. Stocks started out at depressed multiples (a price-to-trailing-earnings multiple of 10.2 for the S&P Composite Index) and finished at inflated ones (26.0 for the S&P 500 Index (INDEX: ^GSPC  ) ). All told, the expansion in the multiple's girth alone fattened stocks' average return by a full 1.25 percentage points annually. Unless you have reason to believe that rising valuations will make the same contribution over your investing horizon, expecting the same average return going forward is wrongheaded.

A more realistic benchmark

Taking a longer observation period (January 1871 to August 2012) over which the change in P/E multiple was less dramatic, I found an average return of 8.61%, with the change in P/E contributing just 25 basis points, and inflation 208 basis points (100 basis points being equal to one percentage point).

8.61% - 0.25% - 2.08% = 6.27%

A reasonable historical benchmark with which to begin thinking about future returns is 6% to 7% after inflation. That range is consistent with the long-run stock return estimates in the 2007 edition of Jeremy Siegel's Stocks for the Long Run.

Incidentally, if you don't think a 1.25 percentage point difference is even worth trifling over, consider the end value of a dollar invested at 6.5% over a 30-year period: $6.61. At 7.75%, you'll have $9.38. If you were counting on the higher return and earned the lower one instead, you're now facing a 30% shortfall.

Myth 2: The longer the time horizon, the safer stocks become
This is an idea that has been heavily marketed based on Jeremy Siegel's observation that, historically, the standard deviation of stocks' average returns has fallen as you extend your time horizon. But Siegel himself is pretty cagey when it comes to the broader implications of that finding. This is what he told an audience of financial advisors in 2004:

One thing I should make very clear: I never said that that means stocks are safer in the long run. We know the standard deviation of [stocks'] average [annual return] goes down when you have more periods ... What I pointed out here is that the standard deviation for stocks goes down twice as fast as random walk theory would predict. In other words, they are relatively safer in the long run than random walk theory would predict. Doesn't mean they're safe. [emphasis added]

In a March 2011 paper, Lubos Pastor and Robert Stambaugh, respectively of the University of Chicago and the University of Pennsylvania, show that stocks are more, not less, volatile over long periods.

Siegel compiled historical return data going back over two centuries, and that is fine as far as describing how stocks behaved in the past (strictly speaking, there are problems with this data, to begin with). Pastor and Stambaugh's argument is that observing historical average returns and extrapolating them into the future leaves investors open to "estimation risk." In short, today's investors don't care what stocks did in the past; the only thing that counts is what stocks do in the future, and even two centuries of data does not allow us to know stocks' expected return with certainty. Once you take that uncertainty into account, Pastor and Stambaugh found that stocks are riskier over longer periods.

4 practical recommendations for long-term investors

Don't cling to investing myths such as the two I have highlighted above. Accepting that they are false means recognizing the seas you must navigate are more uncertain and less hospitable than you once thought. It does not mean that throwing up your hands is all that is left to do. Here are four practical recommendations:

• Time horizon is not the only relevant variable in figuring out your allocation between stocks and bonds (and other asset classes). Your risk tolerance, current earnings, and career risk are all things you should consider.
• Use conservative estimates for the equity returns you require in order to achieve your goals to account for "estimation risk."
• Always remain cognizant of valuations -- particularly when they reach extremes (i.e., bubbles).
• Always strive to keep your costs as low as possible; this makes an enormous differenceover time. In that regard, products like the Vanguard Total Market ETF (NYSE: VTI  ) , the Vanguard Dividend Appreciation ETF (NYSE: VIG  ) , and the Vanguard MSCI Emerging Markets ETF (NYSE: VWO  ) are all excellent choices.

http://www.fool.com/investing/beginning/2012/09/19/the-truth-about-stocks-for-the-long-run.aspx