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What Is “Buy and Hold”?
It is significant that recent discussions and criticisms of “buy and hold written by financial journalists and bolstered by citations from institutional investors, do not bother to define their subject matter. Equally significantly, a private investor (Robert Kleinberg, working in Shanghai, China) has recently expressed the gist of “buy and hold” insightfully and concisely (The Wall Street Journal, 9 July 2002). “When brokers and their firms often encourage excessive trading based on flawed or biased recommendations and ignoring tax consequences, buy and hold is not a mantra but a damn good idea. The question isn’t what’s wrong with buy and hold, but rather what you buy in the first place. If you’re going to hold long term (more than five years), then there’s always risk you’ll be wrong with some of your [decisions]. But if you (as I do) buy a basket of stocks, from several industries, which have the following characteristics:
- Clean balance sheetsSound management and strategy
- Focused on a core business, no gimmicks
- Proven record of steady earnings growth
- Reasonably priced
… then most of them should do well over the long term. You won’t need to buy and sell except for a few that turn out to be duds. Transaction fees and taxes will be minimized, and meantime you own something worth owning.” To “buy and hold” then, is to allocate investment capital (i.e., to buy) on the basis of justifiable and cautious premises, valid logic and hard evidence. It is not, as some have recently implied, to buy on the basis of popularity and without regard to quality and price. Indeed, to buy on the basis of such irrational criteria is the direct opposite of a proper conception of buy and hold. In Graham’s words, “investment is most successful when it is most businesslike. An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.” Having bought a business (or a portion of a business) using businesslike criteria, one then judges the results of one’s purchase using businesslike criteria. One holds in order to participate on a pro rata basis in the success of the business over the years. The results of an investment operation thus have everything to do with the retained earnings and dividends that one’s businesses generate – and nothing whatever to do with the extent to which the prices of their shares (assuming that they trade on a market) fluctuate (see also Value Investing and the (Mis)Measurement of Results). To buy and hold, then, is not (as The Wall Street Journal recently contended), to “argue that stocks go up over time.”
Plus Ça Change: The Intelligent Investor Then and Now
Reading The Intelligent Investor confirms that certain past periods and episodes resemble the present sufficiently closely that they merit careful study. “To invest intelligently in securities one should be forearmed with an adequate knowledge of how the various types of bonds and stocks have actually behaved under varying conditions – some of which, at least, one is likely to meet again in one’s own experience. No statement is more true and better applicable to Wall Street than the famous warning of Santayana: ‘those who do not remember the past are condemned to repeat it.’”
The late 1960s and early 1970s seem to share several characteristics with the present. The first is a general sense of uncertainty borne by events, economic and non-economic and both at home and overseas. “When the young author entered Wall Street in June 1914 no one had any inkling of what the next half-century had in store. (The stock market did not even suspect that a world war was to break out in two months, and close down the New York Stock Exchange). Now, in 1972, we find ourselves the richest and most powerful country on earth, but beset by all sorts of major problems and more apprehensive than confident of the future. Yet if we confine our attention to American investment experience, there is some comfort to be gleaned from the last 57 years. Through all their vicissitudes and casualties, as earthshaking as they were unforeseen, it remained true that sound investment principles produced generally sound results. We must act on the assumption that they will continue to do so.”
The second is an economic boom, followed quickly and unexpectedly by a steep decline in the market prices of many securities, and a consequent feeling of consternation and disorientation. “The extent to the market’s shrinkage in 1969-70 should have served to dispel an illusion that had been gaining ground during the past two decades. This was that leading common stocks could be bought at any time and at any price, with the assurance not only of ultimate profit but also that any intervening loss would soon be recouped by a renewed advance of the market to new high levels. That was too good to be true. At long last the stock market has ‘returned to normal,’ in the sense that both speculators and investors must again be prepared to experience significant and perhaps protracted falls as well as rises in the value of their holdings.”
The third is a belated recognition that most market participants – including many major institutional investors – recently engaged more in frenzied speculation than in sober investment. “In the area of many secondary and third-line common stocks, especially recently floated enterprises, the havoc wrought by the last market break was catastrophic. This was nothing new in itself – it had happened to a similar degree in 1961-62 – but there was now a novel element in the fact that some of the investment funds had large commitments in highly speculative and obviously overvalued issues of this type. Evidently it is not only the tyro who needs to be warned that while enthusiasm may be necessary for great accomplishments elsewhere, in Wall Street it almost invariably leads to disaster.”
Back to the Future
As we saw in Part I, many market participants have responded to these three developments by disavowing the traditional and tried-and-true principles that have recently been bastardised and misrepresented. Graham’s response was to justify and re-emphasise those principles. “What then do we aim to accomplish in this book? Our main objective will be to guide the reader against the areas of possible substantial error and to develop policies with which he will be comfortable … We have seen much more money made and kept by ‘ordinary people’ who were temperamentally well suited for the investment process than by those who lacked this quality, even though they had an extensive knowledge of finance, accounting, and stock market lore.”
“Additionally, we hope to implant in the reader a tendency to measure or quantify. For 99 issues out of 100 we could say that at some price they are cheap enough to buy and at some other price they would be so dear that they should be sold. The habit of relating what is paid to what is being offered is an invaluable trait in investment. In an article in a women’s magazine many years ago we advised the readers to buy their stocks as they bought their groceries, not as they bought their perfume.” Part III details, with respect to the “buy and hold” approach to investment as defined above, Graham’s conviction that “the underlying principles of sound investment should not alter from decade to decade, but the application of these principles must be adapted to significant changes in the financial mechanisms and climate.”
...continued in Part III
 
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