How Long Should You Hold a Stock?

How Long Should You Hold a Stock?

“Our favorite holding period is forever”

• Warren Buffett

This famous quote is from the 1988 letter to Berkshire Hathaway investors. Allow me to provide the full quote:

“In fact, when we own portions of outstanding businesses with outstanding managements, our  favorite holding period is forever.  We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint. Peter Lynch aptly likens such behavior to cutting the flowers and 

watering the weeds.“

Investing in individual stocks is challenging and most investors do not need to invest in individual stocks to be successful. For those investors who do want to invest in individual stocks, here are some of our philosophies for investing in individual stocks that may help or at least give you something to consider.
 

Should You Own Individual Stocks?

In general, you want to get paid for the risk you take in financial markets. For a diversified stock portfolio the lion's share of the returns and volatility in your portfolio will be explained by the returns and volatility of the overall stock market. When you pick individual stocks you are exposing yourself to additional risks that are exclusive to that particular business. If you buy Apple instead of the S&P 500 your returns are driven by the stock market as well as the prospects and risks that Apple carries like input costs rising/lawsuits/bad execution on strategy etc. So to invest in an individual stock you accept this higher risk in exchange for expected higher return.
Data tells us that taking on this extra risk is not rewarded in the long run. If we look at the Russell 3000, which is an index of the largest 3000 companies in the US (roughly 98% of the US Equity Market), you would expect to see the median Russell 3000 company outperform the broader index if “idiosyncratic risk” was rewarded. Using the Russell 3000 ETF $IWV, the index returned 75% over the past 5 years while the median return of a Russell 3000 company is 18.83% This is just one data point that shows investing in individual stocks is very challenging.
 

How We Invest In Individual Stocks?

Our philosophy on investing in individual stocks is based in humility. We don't believe we have any inside knowledge or exceptional ability to forecast returns of stocks better than the wall street consensus. However, we do have the ability to evaluate companies that have a track record of consistent profitability and growth across different macro environments as well as durability in their business model across time.

We look at consensus expectations for revenue/earnings/margins/free cash flow and other metrics for the next few years, and then we look at the company's history of meeting or exceeding consensus expectations to see if those targets are viable. We consider the overall financial health of the company, their ability to service their debt, if they are using debt effectively. We consider how shareholder friendly the company is, do they have a history of share buybacks or dividends, how aggressively do they pursue this, and find where the money comes from to pay for these.

More recently, AI has been a key focus on our fundamental research for companies. Is the company going to be enhanced or disrupted or rendered obsolete by AI? All of these things and more go into the decision to invest, and each of these things carry their own degree of uncertainty. 

Then after considering all of these things, we look at valuation. If you pay too high a price for a stock, the valuation can shrink while earnings are growing and you may still have a poor performing investment no matter how rapid the business grows.
 

So How Long Should You Hold?

If you go through that process and determine that a company is worth investing in, the next question is, how long should you hold the stock? When should you sell it? I will refer back to the original quote, it often gets misquoted that Buffett will buy a stock and hold it forever. In the context of the full quote that is not accurate, in an ideal world the best investment is one that is a good investment today and will still be a good investment 20 years from now. 

Sometimes you will do all of the work and your thoughts & predictions did not play out like you thought they would and you have to make the hard decision to hold on to a loser or still believe in a comeback in the long run. Our view on this is that in general you have to give your ideas a long leash, if you are investing in individual stocks you can't expect to be right on every single time horizon. 

Doing thorough research on the companies you invest in allows you to have conviction during drawdowns to hold or even update your views and maybe realize that you had a misunderstanding and were wrong and can sell. Long term investing does not mean never sell, it just means don't sell based on short term price fluctuations, sell if you no longer believe the things that made you purchase the stock in the first place.
 

Conclusion:

Data shows that investing in individual stocks usually underperforms on a risk adjusted basis for investors. For those looking to invest in individual stocks, we typically recommend a value & quality style of investing with a long term time horizon. Investing in quality businesses backed by your own fundamental research allows you to have confidence during periods of underperformance to hold, and understanding when you are wrong and should sell. We typically select individual stocks that are followed by many analysts and well researched. We aren't trying to find the next microcap that will be 100x, we are looking at adding quality companies that have proven track records over a long period of time alongside diversified portfolios.