Buy and Hold is a viral strategy adhered by many. It is so beloved that any criticism draws the ire of its cult-like followers. When I began my investment career, I was advised to buy stocks of a good company, stay invested and reap its benefits. But I learned the hard way of this misinformation.
So, let me break the myth.
In 2010, three professors conducted a study on Warren Buffet's investments. In their research, "Overconfidence, Under-Reaction, and Warren Buffett's Investments", John Hughes, Jing Liu and Mingshan Zhang studied how investment experts and traders contribute to market underreactions based on Berkshire Hathaway's actions. The study inferred that the median holding period is a year, with 30% of stocks held less than 6 months.
Most people cite Warren Buffett’s buy and hold investing philosophy yet have not yet understood Warren Buffett. As an astute investor, Warren Buffet does not blindly believe in buy and hold. Rather, he looks into the intrinsic value of a stock after deeply studying the company thoroughly.
In fact, Berkshire Hathway, Buffet’s company, pared its stakes in 2021 three drug stocks—AbbVie, Bristol-Myers Squibb, and Merck, which he acquired in 2020.
Avoiding the risks associated with buy and hold
As a passive investment strategy, buy and hold involves buying stocks and holding them for an extended period, regardless of market fluctuations. That means, if you have invested in a good company several years ago, the strategy states you need to stay invested in creating wealth. But if it was so easy, all of us would have been millionaires.
A company that was good eons ago may deteriorate over a while and may not make the kind of returns you've been expecting. Even the best-of-the-best companies go through a change and shift in paradigms over time. Either the business they are into is no longer relevant, or the management cannot capitalize.
Imagine if you had invested in companies such as Lupin, GMR Infra, J P Associates, P C Jeweller, DHFL, YES Bank, INDUSIND Bank, Manpasand, Future Consumer etc., a decade or even 20 years ago. According to the buy-and-hold strategy, these stocks that held promise could not generate wealth for investors down the line.
Similarly, in 2000, Wipro was touted as an example of buy and hold strategy, in 2008, it was Larsen and Toubro. Then there was ITC in 2011, Eicher Motors in 2016 and HFC bank in 2020. HDFC Bank underperformed for 5 years in a row, so has Maruti Suzuki, failing to create wealth for its investors.
Typically, investors are quick to book profits on a well-performing company, but if a company is losing money, they tend to adopt the buy and hold strategy in the hopes it would do well. Unfortunately, such a long wait never ends, subjecting us to the Recency Bias.
With recency bias, we place greater emphasis on recent events, leading us to believe a current stock market downturn or rally will extend into the future. This bias can lead us to make short-term decisions that deviate from our financial plans.
The fact is that only one in 200 companies will create wealth in a buy-and-hold strategy. The remainder 199 could underperform or fail to create wealth in the long run. Therefore, it is crucial to find the right company that could build wealth as it is rare to glean a stock that holds such potential. Take for instance, an investor who purchased Deepak Nitrite or Alkyl Amines a decade ago, could continue to hold on to it in the hopes it would create wealth in the future.
Why you need to reconsider buy and hold
In fact, about 1% of all companies have created more than 60% CAGR in buy-and-hold strategy and barely one-third have given less than 10% returns. In the same time frame, the Sensex gave 11.16% CAGR. According to our research, several companies that fall above the ₹500 crore market cap survived but got delisted in the 10-year time frame. Below is a set of companies from our research where the buy-and-hold strategy did not work.
In the above table, while Sensex rose 204%, the companies mentioned above barely moved up.
Buy and hold works. Here’s how and When
No one can buy stocks at the bottom and sell them at the top. Opportunity loss is a significant factor to watch out for. Hence, not selling a company at the right time could cost a lot. As an investor, you need a disciplined approach that will help you emerge as a successful investor.
Like Buffet, you too need to care deeply about a company's magnitude and resiliency towards its long-term return on capital. When assessing the quality of a business, investigate several parameters or metrics to collectively assess the company's profitability, growth, safety, and payout ratio to determine if it can be a buy and hold stock.
The buy and hold strategy works, provided you have the right temperament. Unfortunately, not many investors have that kind of disposition. Not all companies will work under a buy-and-hold strategy. Hence, your asset allocation to those companies must be right.
Crucial to stay Nimble-Footed
The idea is to move with the times. Hence, it is not advisable to have fixed holding period for any company. It is essential stay nimble footed as the world has become an integrated entity and situations tend to change dynamically. A buy-and-hold strategy requires equal attention to the “hold” part.
Before you invest in equity markets, it is essential to take the time to study the strategies available to you, including passive investing. Like every subject in finance, investing knowledge and awareness is priceless. So, while buy-and-hold works in specific scenarios, it is not the right strategy if one blindly invests through it.
Thorough research and asset allocation along with the right stock selection will lead to winning trades in times of unusual volatility. For timely and in-depth research on interactive tools and high-growth stocks, investors must consider the expertise of financial advisors, adept at recognizing the right stock at the right time.
Sunil Damania is the Chief Investment Officer of MarketsMojo