Buy and hold isn’t dead, but its DNA sure could use a bit of genetic engineering.
Buy and hold was never intended as buy and forget, but a great bull market run like the one that stretched from 1982 to 2000 made it seem like all an investor had to do was buy and then remember to add up the profits from time to time.
The bear markets that began in 2000 and 2007 have demonstrated exactly how dangerous buy and forget could be. In the first bear, from March 2000 through October 2002 the Standard & Poor’s 500 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%.
The experience of those two bear markets have left many investors reluctant to buy stocks at all—for most of the rally in 2009 off the March lows individual investors have been busy withdrawing money from stocks and putting it into bonds. And it’s left most of those willing to buy stocks as skittish as whitetail deer in hunting season: Never able to relax and always ready to bolt for escape.
But the original advantages of long-term investing aren’t extinct. Long-term investors can still take advantage of temporary panics and mis-pricings to build positions at low costs. They can still put time to work for them by buying the stocks of companies with a high return on invested capital and letting those companies compound those returns over the years. 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 a review as infrequently as annually will do the trick, I believe.
So as we start this new decade I’m going to give you ten stocks for the next ten years.
Five of those are holdovers that I think are especially appropriate now from the buy and review Jubak Picks 50 portfolio that I explained in my December 2008 book The Jubak Picks and that I launched as a portfolio that December. As of the close on December 31 that portfolio has gained 57.8% since it was launched on December 30, 2008. That compares to a 28.3% gain for the S&P 500 and a 50.2% gain for the NASDAQ Composite Index.
Five of those will be new stocks to replace the five that I’m dropping from the portfolio as part of this annual review.
In 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—and that have worked so well over the years.
The buying rules involve looking for companies with
- a lasting competitive edge. Morningstar.com calls this edge a “wide moat.” 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 assures their continued dominance in a market.
- a return on invested capital that’s higher than that at competitors. This is insurance since it means that a company will have lots of profits 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) that demonstrates that this is a company that doesn’t fall asleep at the switch, that knows how to press its advantage over competitors, and that 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—since companies don’t survive for the long term unless they take risk—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.
And 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 that 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 macro 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 a loan to buy a horseless carriage.
Reviewing my list of 50 stocks from last December, I’d say that four stocks deserve to be sold from the portfolio. (You can see the entire list and a brief explanation why I originally bought each stock at http://jubakpicks.com/jubak-picks-50/ . In many cases I’ve updated those original reasons to reflect more recent news on the company and the stock.)
Accor (ACRFF.PK) In a very controversial vote Accor’s board of directors voted on December 15 to split the company into two businesses. Accor Hospitality would focus on the company’s hotels and Accor Services would focus on voucher and pre-paid services. Activist shareholders Colony Capital and Eurazeo, which together hold 30% of the company’s shares, argued that splitting up the company would unlock value for shareholders. The French government, which holds 7.5% of shares, argued that it was risky at a time when it was 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 is risky to split up the two businesses for exactly the reason that the government investment fund noted. But a split might light a fire under the hotel division, which has been reluctant to give up a real-estate heavy business model in which it preferred to own hotels for the capital-light model adopted by other hotel chains. In that model hotel companies have sold real estate and rely on partners for investment in hotel properties while the hotel company concentrates on managing hotels on a fee basis. What concerns me isn’t so much the outcome of the vote but the erosion of good corporate governance at Accor. Executive chairman Gilles Pelisson, who had initially opposed the breakup on grounds that neither business really stood alone—the voucher and services business, he argued, wasn’t geographically diverse enough to stand alone since 40% of revenue came from Latin America—wound up supporting the deal proposed by Colony Capital and Eurazeo. Six company directors resigned in February when Pelisson added the job of chairman to his role as chief executive. Under the breakup approved by the board and backed by Colony Capital and Eurazeo, Pellison would head the hotel unit if shareholders approve the breakup.
ING (ING) When the reason you bought a stock no longer applies, you sell. I bought ING 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 the middle of 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 lending 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 $15 billion injection of cash from the Dutch government in October 2008 and about $33 billion in government loan guarantees. Now, in October 2009, 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 United States. 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 sure not the business I bought when I added ING to the Jubak Picks 50. Gone is the whole strategy—at least for the conceivable future—of moving assets from Europe to faster growing markets and going after the growing middle class in Asia and Latin America who wanted banking and insurance products.
Q Cells (QCLSF.PK). 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 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 Holdings (STP) that are currently 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 Euros per watt.
Tejon Ranch (TRC). This isn’t so much a negative judgment on Tejon Ranch but on the state where all its real estate is located: California. The state’s politics are completely dysfunctional. Its tax system is broken. It’s vaunted quality of life—that once included such things as the best state university system in the country with a quality at many campuses that equaled 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.
My fifth stock isn’t a sell but a drop: Warren Buffett’s Berkshire Hathaway (BRK.A) is buying the Burlington Northern Santa Fe (BNI) railroad for $100 a share.
And my replacements for these five stocks? Since the global trends that I outlined in my book The Jubak Picks 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, from companies that are better candidates for long-term investing.
- Canadian National Railway (CNI). With Warren Buffett’s purchase of Burlington Northern (BNI), there’s one less trans-continental 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 64%% from 90% over the last decade, according to Morningstar, and the company’s 10-year free-cash flow is more than 13% of revenue.
- Ctrip.com (CTRP). 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 products. Hotel and airline ticket revenue at Ctrip.com grew by 41% and 45%, respectively, year to year in the third quarter. 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, year to year in the third quarter.
- Deltic Timber (DEL). This company owns 439,000 acres of timber land in Arkansas and Louisiana. Most of that the company uses to produce timber and pulp wood, but the company is turning an increasing piece—well at least 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. This year probably marked a bottom for Deltic’s real estate operations. In the third quarter the company sold a total of 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 (SCBFF). Despite its London headquarters, Standard Chartered Bank does most of its business outside the United Kingdom. (A good place not to be during the global financial crisis.) In fact 90% of profits come from its business in Africa, Asia, and the Middle East. Formed 150 years ago by the merger of The Chartered Bank of India, Australia and China and the Standard Bank of British South Africa in 1869, 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 Bros. 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 (SPWRA). 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, since prices are dropping like a stone and many companies, such as Q Cells, are struggling to cut costs faster than prices are falling. SunPower’s way out of that bind is through vertical integration from manufacturing through installation. The services it provides to solar dealers and installers save dealers and installers significant costs, which lets the company charge slightly higher prices for its solar modules. I don’t think SunPower is ignoring the need to cut manufacturing costs, however. In fact one of the reasons that I like this solar manufacturer is that it’s roots are in the silicon chip industry so it gets the way that higher quality and increased power generation per module can make up for lower labor costs at some competitors.
Besides these five new additions/replacements to the portfolio, What five stocks from the 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 (CEDC) because growth in Eastern Europe is just starting.
- Goldcorp (GG) because the 10-year trend is toward gold as a hedge against increasingly devalued currencies.
- Potash of Saskatchewan (POT) because the world needs to feed more people every day
- Schlumberger (SLB) because the development of Iraq’s huge oil reserves is going to need a lot of technology
- Suntech Power Holdings because solar power is at the beginning of its growth curve and because costs count.
You can find all these buys and sells, and continuing updates on my Jubak Picks 50 portfolio page at JubakPicks.com.
Full disclosure: I own shares of Central European Distribution, Ctrip.com, Deltic Timber, Goldcorp, ING, Potash of Saskatchewan, Schlumberger, Standard Chartered, and SunPower in my personal portfolio. I will sell my shares of ING three days after this is posted.