The logic behind Buffett's equity holding period - The 5 Minute WrapUp by Equitymaster
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The logic behind Buffett's equity holding period 

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In this issue:
» Infosys' guidance causes IT stocks to jitter
» China's debt woes
» Top and worst performing sectoral indices
» Baltic Dry Index sees its biggest drop in six years
» ...and more!


00:00
 
'Invest for the long term' or 'Invest from a long term perspective.' These are statements that equity investors are suggested quite often. But how long is 'long term'? Is it one year? Or could it be anywhere between three, five, ten or more years? There's no precise duration for the same.

Or is there?

As per the study a study conducted by the business daily Mint, the chances of long term investors not losing money in stocks would be nil, had they invested for a minimum period of seven years. This was calculated by taking the minimum returns over this period in the past seventeen years.

The business daily did the study by taking the Sensex Total Return Index (TRI) - one that is different from the value of the Sensex that we see on the new channels; TRI includes reinvestment of dividends that are paid out (similar to a growth mutual fund scheme) - and studying the investment periods as to gauge the average, minimum and maximum returns from the same. The business daily treated the index as a mutual fund with its daily price being treated as the net asset value or NAV.

As per the study, for investments made for a period of one year, the chances of losing money stood at nearly a third of the times. Similarly, for periods of two, three, four, five and six years, the chances of losing money in investments held for such durations stood at 23%, 14%, 13%, 8% and 4% respectively. The minimal returns from these periods also stood in the negative region, while average returns remained sub-par.

However, the study concluded that for investments held for a minimum of 7 years, an investor would have not lost money in the stock markets. The worst positive return would have been a figure of 3% average returns for stocks held for seven years. It also concluded that the longer were the holding periods, the higher were the annual returns. If one would have invested in the Sensex (TRI figure) for duration of seventeen years i.e. since August 1996, the minimum returns would have been at 12% per year (14.53% maximum).

Now, while seven years may or may not be a number that everyone would agree with - given it's a pretty long duration - we, nevertheless, are entirely in favour of the conclusion of the study - that equity investing delivers strong returns over longer periods. As pointed out by a fund manager in the same article, a longer term investment horizon allows fundamentals to drive stock prices. In the short term, other factors such as sentiments play a major role in determining the same.

We could not agree anymore. In fact, we believe this could be a good enough definition of 'investing from a long term perspective'.

We believe the chances of improving these statistics would be high by practicing low P/E investing. This would ideally curb the chances of investors putting money when markets are heated, thereby allowing them to report above average portfolio returns over the longer periods.

According to you, how many years should one hold on to stocks in order to allow the fundamentals to drive prices, rather than sentiments? Share your views in the in the Equitymaster Club. Or post your comments below.

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01:25  Chart of the day
 
Even as the Sensex hit an all-time high, majority of the sectoral indices are still far away from their lifetime highs, which they had scaled in January 2008. Currently, the rally is largely driven by export-driven stocks, with shares of company's dependant on domestic demand languishing on account of the economic slowdown. According to an article in Mint, out of 11 BSE sectoral indices, only three are within 10% of their record highs. They are information technology, healthcare, and auto indices. The stocks in these sectors have benefited from a weaker rupee and strong rural demand. Today's chart of the day shows that only IT, healthcare, and auto index are within 10% of their record highs, while shares from realty, power and metal indices are 50% off their highs.

Top and Worst Performing Sectoral Indices
HC- Healthcare, IT - information technology

However, one would do well to keep in mind that going by the broad view on the sector - as seen through the performance of the respective indices - may not be the proper way to invest in stocks. This we say because of two key reasons. One being that the weights that select stocks have in some of these indices tends to be quite large, thereby easily influencing the index on the whole. Secondly, the fundamentals of each of the stocks forming part of a particular sector are different; as such indicating that the bottom up approach would be a better way to approach the process of stock selection.

02:20
 
If you can count Warren Buffett amongst your admirers, you really are onto something we reckon. That's Seth Klarman for you. Klarman, one of the most widely followed value investors, has used the analogy of the English movie 'Truman Show' to describe today's markets. In the movie, the central character thinks he is living a peaceful suburban life only to realise later that he's nothing but the lead actor of a hugely popular reality show. Well, as per Klarman, it is Ben Bernanke and Mario Draghi who are playing the role of creators in today's market environment. And they have done nothing but artificially created a hugely profitable environment for investors. Unfortunately, every Truman knows that the environment is not what it seems like on the surface as per Klarman. But the mood is so euphoric and the profits so easy to come by that no one wants to get out. Will this continue forever, Klarman asks. Certainly not! When the show ends the Trumans are likely to be mad as hell and perhaps out of money as well, Klarman adds further. And hopefully there will be no sequels he concludes. Well, we couldn't have agreed more.

02:55
 
Seasoned investors would recall that this is not the first time markets have reacted sharply to Infosys' earnings guidance. The software behemoth, despite muted profitability and lower growth, has retained the influence over investor sentiments. Investor sentiment not just towards the stock but the entire IT sector tends to get impacted by Infosys' guidance. The brokerages typically look forward to quarterly earnings outlook. And this makes the software sector extremely vulnerable. A lower earning guidance from even a single player tends to take a toll on valuations for the entire sector. And being amongst the first of the lot to declare results, Infosys is invariably the trend setter. Now whether the valuation of the sector by itself is reasonable enough is a discussion for another day. The fact is that once again a red signal from Infosys has cast a shadow on the fundamentals of the entire sector. And the market has lost no time to downgrade the valuations of almost every player. For investors, this may be a good time to look out for fundamentally resilient companies that are available at a discount.

03:45
 
Lead economic indicators provide crucial input in forecasting future growth rates. Baltic Dry Index (BDI) happens to be one such indicator. It measures the movement of freight cost while transporting dry bulk cargo via sea. Indirectly it is a measure of trade activity across the globe. An increase in global demand for commodities indicates that production is bound to increase. And that demand movement is tracked via the trade activity. BDI does this job. Thus, it signals beforehand that economic growth is bound to improve or decline. Hence, it is avidly followed by many.

But what it is hinting currently? A complete doom, it seems. The BDI plunged 8% in a single day which is probably the biggest drop in last six years. Peaking Chinese inventory at ports signify that movement of bulk cargo has slowed down. And this has led to a fall in the index. This is not good news. It signifies that global demand has slowed down at least for iron ore which is a widely used industrial commodity. Slowing demand will jolt production and hurt global growth rates. Thus, it seems that the global recovery may take longer than usual.

04:25
 
Debt is not really a bad thing. It is, in fact, a great catalyst for economic growth. But debt can prove to be a double-edged sword if not used with restraint. We have seen how excess leverage has not just killed many corporates but has even brought countries down on their knees. China's phenomenal growth would have been impossible without debt. But it seems that the dragon economy's growth model of debt-driven investments has run its course. The economy is now sitting on a mountain of debt coupled with slowing growth prospects. Over the last six years, China's overall debt levels have shot up by 95 percentage points to 244% of GDP in 2013. This is the highest in Asia. Its ability to service its debt has been deteriorating. These are indeed ominous signs. While the dragon economy has proved many 'China bears' wrong in the past, if they proved right even once, it would wreck havoc not only in China but the entire global economy.

04:50
 
In the meanwhile Indian stock markets remained firm. At the time of writing, the benchmark BSE Sensex was up by 81 points (+0.4%). Energy and banking stocks were the biggest gainers. All the major Asian stock markets were trading positive led by China and Taiwan while Japan was trading down. Majority of the European indices opened the day on a firm note.

04:55  Today's investing mantra
"If our success were to depend upon insights we developed through plant inspections, Berkshire would be in big trouble. Rather, in considering an acquisition, we attempt to evaluate the economic characteristics of the business - its competitive strengths and weaknesses - and the quality of the people we will be joining."- Warren Buffett
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3 Responses to "The logic behind Buffett's equity holding period"

Frederick

Mar 15, 2014

Hi
If u hold stocks of top dividend & bonus share payers for an unlimited period u will rarely loose take 2008 market crash? or !
Regards.
Fred

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K.N.Ravichandran

Mar 14, 2014

A good quality stock is to be held sufficiently long years ( exceeding 10 years and thereafter for substantial appreciation and gains . The right timing of the investment in such a stock would be an added booster. The difficulty arises in identifying such stocks and follow up with the market on continued identification of such stocks and investment so as to achieve multiple growth.

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suresh bajaj

Mar 13, 2014

I am of the opinion that an investor should be prepared to wait for at least 10 years if he is entering into stocks.

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