Discovering Value


Buy and Hold Is Risky

Whitney Tilson
John Heins

Now more than ever, you need to maintain constant vigilance in monitoring your portfolio.



In its August 14, 2000, issue, Fortune went out on a limb with an article titled “10 Stocks to Last the Decade.” The story described a “buy and forget” portfolio meant to capitalize on overarching trends the magazine predicted would dominate the next ten years. It recommended two companies in each of four categories -- media (Viacom, Univision), finance (Charles Schwab, Morgan Stanley), technology (Broadcom, Oracle) and telecommunications (Nokia, Nortel) -- as well as Genentech and, ahem, Enron.

An investor building a portfolio with these stocks would have wanted to forget about it, all right, but not for the reason the magazine intended. From the magazine’s issue date through the end of 2009, precisely one stock, Genentech, rose in value. The next-best performer, Oracle, was down 34%. Enron shares were worthless and Nortel shares very nearly so. Overall, an equally weighted portfolio of the ten stocks would have lost 44%. Standard & Poor’s 500-stock index (without dividends) was a big winner in comparison, down only 24% over the same period.

We bring this up not to ridicule Fortune, which is consistently one of the smartest and best-written business publications. Rather, we want to point out a few of the many worthy lessons here.

Buy and hold isn’t what it used to be. We’d be the last to recommend frequent trading, but buying and forgetting in a world roiled by rapid change is an increasingly risky proposition -- especially when it comes to technology. Nokia was the king of cell phones, but as it lost a few product-cycle rounds to rivals, its descent from the throne was sharp and fast. Now more than ever, you need to maintain constant vigilance in monitoring your portfolio.

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Never underestimate the competition. Fortune thought Charles Schwab and Morgan Stanley would be prime beneficiaries of what it called a sweeping trend -- the “boomerization” of financial services. But as legions of competitors stepped up to capitalize on this trend as well, the road to riches envisioned for Schwab and Morgan Stanley became somewhat rockier, even before the 2008 financial crisis. Although long-term demographic and market trends are powerful, a company still needs to have a strong competitive advantage to succeed.

Valuation matters. Can you guess what the average price-earnings ratio was of the stocks on Fortune’s list? Would you believe 100? Oracle, the software giant, produced perfectly fine results over the past decade; but as its P/E shrank from 86 to 21, its shareholders suffered. How a stock fares depends not only on the performance of the underlying company but also on how that performance compares with investors’ collective expectations, as expressed by the price they pay to buy the stock. That’s something to keep in mind every time you buy a stock, especially if you’re betting on well-known “sweeping trends.”

After one of the sharpest rallies ever, the stock market now looks expensive. In mid January, it traded at 21 times average trailing, inflation-adjusted earnings over the past ten years, compared with a historical average of 16. Such a rich P/E is warranted only if the economy stages a sharp recovery, which in our opinion is possible but not likely. If we’re right, many investors will be disappointed yet again, having made the same mistake Fortune made a decade ago: projecting the immediate past indefinitely into the future.

Rather than make overly optimistic assumptions and risk painful disappointment, we prefer to be pleasantly (and profitably) surprised if things turn out better than we anticipate. Thus, we’re selling short more stocks, trimming many of our existing holdings and refocusing our long port-folio on blue chips, such as Berkshire Hathaway (symbol BRKB), Pfizer (PFE), Microsoft (MSFT) and Yahoo (YHOO).

Columnists Whitney Tilson and John Heins co-edit Value Investor Insight and SuperInvestor Insight.



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