Buy-and-hold was never intended as buy-and-forget, but a great bull market like the one that stretched from 1982 to 2000 made it seem like all an investor had to do was buy and then add up the profits from time to time.
The two bear markets of the past decade have demonstrated exactly how dangerous buy-and-forget can be. In the first bear, from March 2000 through October 2002, the Standard & Poor's 500 Index fell 47%. In the second bear, the one that began in October 2007 and may have bottomed (let's hope) in March 2009, the S&P 500 lost 56%.
Those bear markets have left many investors reluctant to buy stocks at all. As the market has rallied since March, individual investors have been busy withdrawing money from stocks and putting it into bonds. Most of those willing to buy stocks are like skittish white-tailed deer in hunting season -- never able to relax and always ready to bolt.
But the original advantages of long-term investing aren't extinct. Long-term investors can still take advantage of temporary panics and build positions at low cost. They can still catch long-term trends that can power a company's stock for years without being sidelined by worries about catching the best price.
All that buy-and-hold needs is a transformation from buy-and-forget to buy-and-review. Even reviewing as infrequently as annually will do the trick.
10 for the long haul
Five are holdovers from the buy-and-review Jubak Picks 50 portfolio that I launched with my December 2008 book, "The Jubak Picks," and I think they're especially appropriate now. The portfolio has gained 57.8% since then (through 2009). That compares with a 28.3% gain for the S&P 500 and a 50.2% gain for the Nasdaq Composite Index over the same period.
The other five are new stocks to replace five I'm dropping from the portfolio as part of this annual review.
With these buys and sells, I'm not trying to reinvent the wheel. I'm using the rules developed by long-term investors over the years -- rules that have worked well.
The buying rules involve looking for companies with:
- A lasting competitive edge. Morningstar calls this edge a "wide moat." Investor Peter Lynch famously advised looking for businesses that even an idiot could run, because one day an idiot will. Other long-term investors, such as Warren Buffett, look for companies that have built up the value of a brand name that ensures their continued dominance in a market.
- A return on invested capital that's higher than that of competitors. This is insurance, because it means that a company will have lots of profit to reinvest (at a higher-than-average rate of return) in staying one step or more ahead of competitors.
- A history of research and development (or acquisition and development) demonstrating that the company doesn't fall asleep at the switch, knows how to press its advantage over competitors and can manage the change that sweeps through all parts of the global economy with increasing power these days.
- A conservative management style that can balance risk -- because companies don't survive for the long term unless they take risks -- with safety. Things can still go wrong at companies like these, but conservative management avoids bet-the-company gambles.
- An ability to recognize long-term global economic trends and to ride them even at the cost of disrupting the company's existing business.
The simple selling rules include:
- Sell when the reason you bought the company in the first place no longer applies.
- Sell when the long-term trend the company is riding turns in a direction the company didn't expect or dissipates entirely. No use investing in even the world's best buggy-whip company when cars are replacing horses.
- Sell when the larger picture -- for a market or for an economy as a whole -- heads south. No use investing in cars, even if they are replacing horses, if a financial panic makes it impossible for customers to get loans to buy horseless carriages.
Reviewing my list of 50 stocks from December 2008, I'd say that five stocks deserve to be dropped from the portfolio. In many cases, I've updated those original reasons to reflect more recent news on the company and the stock.
5 stocks on the way out
Activist shareholders Colony Capital and Eurazeo, which together hold 30% of the company's shares, argued that splitting the company would unlock value for shareholders. The French government, which holds 7.5% of shares, argued that it would be risky -- at a time when it's still difficult to raise capital -- to split the company's cash-cow vouchers-and-services business from its capital-hungry hotel division.
I think both sides have a point. It would be risky to separate the two businesses for exactly the reason that the government investment fund noted. But a split might light a fire under the hotel division.
What concerns me isn't so much the outcome of the vote but the erosion of good corporate governance at Accor. Executive Chairman Gilles Pélisson, who had initially opposed the breakup on grounds that neither business really could stand alone, wound up supporting the deal proposed by Colony Capital and Eurazeo. Six company directors had resigned in February when Pélisson added the job of chairman to his role as chief executive, a type of consolidation of executive authority frowned upon by many corporate-governance watchdogs.
Under the proposal approved by the board and backed by Colony Capital and Eurazeo, Pélisson will head the hotel unit if shareholders give their OK.
ING Groep: When the reason you bought a stock no longer applies, you sell. I bought ING Groep on this relatively straightforward story: The Dutch banking and insurance giant was redeploying assets from its mature markets in Europe into growth markets in the developing economies of the world. That, I thought, made this a good stock to buy in order to participate in the higher growth of the developing economies of Asia and Latin America.
Well, a little problem called the U.S. mortgage-market crash interrupted this plan. ING had started up a very successful effort at gathering deposits via the Internet in the United States, called ING Direct. By offering higher rates than local banks, ING Direct had gathered $75 billion in deposits by mid-2009.
The speed of that growth put ING in a bit of a bind. It was taking in deposits in the United States faster than it could deploy the capital in its own mortgage business. So to keep its deposits balanced with its loan assets, ING began to buy mortgage-backed securities. That portfolio grew to about $50 billion. And when the mortgage market blew up, so did that portfolio. ING wound up needing a $15 billion injection of cash from the Dutch government and about $33 billion in government loan guarantees.
Regulators for the European Union are making ING pay the price for that government aid. They are forcing ING to break up into two pieces, banking and insurance, and to sell off its insurance unit as well as its ING Direct business in the U.S. What will be left after the sale will be a predominantly European bank.
That may or may not be a good business, but it's surely not the business I bought when I added ING to the Jubak Picks 50 portfolio. Gone is the whole strategy of moving assets from Europe to faster-growing markets and going after the growing middle class in Asia and Latin America.
Q Cells: Solar has become an impossible business -- even if you are the largest independent producer of solar cells in the world -- if you can't get costs under control. Q Cells is in the midst of layoffs, write-downs and asset sales that are intended to fix what is now an uncompetitive cost structure.
Unfortunately, I don't see the steps the company has taken so far as being enough to fix the problem, and I'm afraid that by the time it does, Q Cells will have lost significant market share to companies such as Suntech Power that are badly undercutting Q Cells on price.
In the third quarter, for example, Q Cells saw an average selling price of 1.11 euros per watt. Suntech Power and other Chinese solar companies are selling their cells at 0.80 to 0.90 euro per watt.
Tejon Ranch: This is a negative judgment not so much on Tejon Ranch as on the state where all its real estate is: California. The state's politics are completely dysfunctional. Its tax system is broken. Its vaunted quality of life -- which once included such things as the best state university system in the country with a quality at many campuses equaling that of much more expensive private universities -- is decaying.
The value of real estate depends on the quality of the public infrastructure, and California's crisis makes the land that Tejon Ranch owns less desirable.
Burlington Northern Santa Fe: My fifth drop is Burlington Northern Santa Fe . Warren Buffett's Berkshire Hathaway plans to buy all of the railroad for $100 a share, meaning I don't have a choice about selling.
And 5 I'm buying
My replacements for these five stocks? Since the global trends that I outlined in my book are still going strong, despite the global economic slowdown and financial crisis, I've looked for stocks that will profit from the same trends that my sells represented. They're just, I trust, companies that are better candidates for long-term investing.Canadian National Railway: With Buffett's purchase of Burlington Northern, there's one less publicly traded transcontinental railroad in North America. And nobody is going to build another one anytime soon. Actually, make that ever. Canadian National Railway generates the highest operating margins among North American railroads. Its operating ratio -- that's the ratio of operating expenses to revenue -- has climbed to 90% from 64% over the past decade, according to Morningstar, and the company's 10-year free-cash flow is more than 13% of revenue.
Ctrip.com: This Chinese online travel company is my replacement for Accor as a way to profit from the increased travel in China that comes with rising income. Ctrip.com seems to be profiting from this trend in two ways. First, its business is growing as more Chinese book airline tickets, hotel rooms and other travel services. Third-quarter hotel and airline ticket revenue at Ctrip.com grew 41% and 45%, respectively, from a year earlier. Second, the company looks like it's grabbing market share from smaller travel operators.
According to Deutsche Bank, Ctrip.com's nearest competitor, eLong, grew hotel and airline ticket revenue by just 5% and 27%, respectively, over the same period.
Deltic Timber: This company owns 439,000 acres of timberland in Arkansas and Louisiana. Most of that Deltic Timber uses to produce timber and pulp wood. The company is turning an increasing piece -- well, it was increasing until 2007 put the kibosh on the real-estate market -- into commercial and residential projects, including its flagship Chenal Valley, a 4,800-acre community built around two Robert Trent Jones golf courses.
Last year probably marked a bottom for Deltic's real-estate operations. In the third quarter, the company sold four lots and no commercial real estate. Lot prices tumbled to an average of $63,000 in the quarter from $74,000 in the third quarter of 2008, when the company sold seven lots.
Standard Chartered Bank: Despite its London headquarters, Standard Chartered Bank does most of its business outside the United Kingdom -- and outside the U.K. is a good place to be during the global financial crisis. In fact, 90% of the bank's profit comes from its business in Africa, Asia and the Middle East.
Formed in 1869 by the merger of the Chartered Bank of India, Australia and China and the Standard Bank of British South Africa, the bank has spent the financial crisis picking up bits and pieces of business from its more hard-pressed peers. For example, the bank moved into Brazil by acquiring the Lehman Brothers team in that country. I think this is a good alternative to ING as a way to invest in the growth of financial markets in what is still so quaintly called the developing world.
SunPower: Demand will pick up, eventually, for solar energy companies as the global economy crawls toward recovery and as countries add more incentives for clean power. That doesn't mean that everyone is going to make money, though, because prices are dropping like a stone and many companies, such as Q Cells, are struggling to cut costs faster than prices are falling.
Besides these five additions, which five stocks from my existing list would I target now as the best place to put some new money for investors with a 10-year time horizon?
- Central European Distribution , a maker and distributor of alcoholic beverages, because growth in Eastern Europe is just starting.
- Mining company Goldcorp , because the 10-year trend is toward gold as a hedge against increasingly devalued currencies.
- Fertilizer-maker Potash of Saskatchewan , because the world needs to feed more people every day.
- Oil-services company Schlumberger , because the development of Iraq's huge oil reserves is going to need a lot of technology.
- Suntech Power, because solar power is at the beginning of its growth curve and because costs count. ( msn.com )
very nice................
ReplyDeleteThanks for the interesting and informative post. I look forward to more in the future.
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