Does Buy and Hold Strategy Work in Long Term Investing?

Know the Difference Between Investing and Speculation

step one is knowing the difference between investing and speculation. You can't become a successful long-term investor if you don't know if you're investing or not.

So here's the definition of investing by the Dean of Wall Street, Benjamin Graham, himself.

An investment operation is one which upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are termed as speculative.

In simple words, putting your money in a stock which has a good financial track record and is trading at decent valuations, is an investment.

On the other hand, putting your money in a stock that's loss making or paying too high a price for a good quality stock will most likely qualify as a speculation.

Now with that out of the way, here's a checklist for all you long-term investors out there. Then we will discuss the 'buy and hold strategy'.

Use This Long term Investing Checklist

• Debt

  It's always a good idea to start with debt levels of the company you are considering.

  Ideally the company should have very little debt or should be debt free. Many fundamentally strong stocks have zero debt.

  You can check out this list of debt free companies.

  Also it's a good idea to look for companies that are actively reducing their debt. While they may have some debt today, they are unlikely to be badly affected by rising interest rates.

  Here's a list of the top companies reducing debt.

• Dividends

  Next, you should check the dividend payout.

  The fundamentally strongest companies have rock solid cash flows. They often share this cash with investors as dividends. The best companies usually have a long track record of dividend payments.

  In a stock market downturn, dividend paying stocks are in high demand as investors prefer the safety of the cash flow that dividends provide over capital gains.

  These stocks can also provide good dividend yields during a market crash. This is because they tend to fall initially along with the rest of the market.

  But as soon as their yields become attractive enough, investors jump in and buy them.

  This means high dividend paying stocks have an in-built stop loss.

  Check out the companies with the highest dividend payouts and the highest dividend yield stocks.

  There are also excellent companies that raise their dividends every year. In these stocks you get the benefit of capital appreciation as well as rising dividends.

  They are called dividend growth stocks. Check out the list of dividend growth stocks.

• Growth

  Companies that maintain good sales and profit growth during a stock market downturn as always in demand. Check for good growth in topline and bottomline. The higher the better.

  The market knows these stocks are essentially getting cheaper. This is because high growth increases per share earnings at a fast pace. This combined with a falling market makes these stocks attractively valued. At a certain point, deep-pocketed invests start buying these stocks.

  In fast growing stocks get to this point sooner than slow growing stocks. Unfortunately, these stocks tend to be overvalued at the start of the correction, so they more downside.

  It's a waiting game with high growth stocks. If you invest too soon you may end up buying the stock before its valuation has corrected sufficiently. But if you are patient, the stock market will present you with a golden opportunity to buy these stocks at a great price.

  Check out the list of fastest growing companies as well as the top growth stocks in the market.

• Past Track Record

  While no investor makes profits in the past, it's still important to look at the past as a guide.

  If a stock has been a multibagger in the past, it's worth checking out if it was driven by fundamental reasons or by speculation.

  If the reason was strong fundamentals, and those fundamentals are still intact, you could have a multibagger stock on your hands.

  Check out this list of multibagger stocks.

• Return on Equity

  The return on equity is one of the best measures of a quality company.

  High return on equity along with low debt is a great combination to focus on when looking for stocks with the best fundamentals. All great long-term stocks have good ROE. Just be sure to use it along with metrics like high growth and low debt.

  If you rigorously filter out low ROE stocks, you will get a list of stocks with high ROE.

Buy and Hold Strategy

Instead of trying to time the market by frequently buying and selling, this strategy focuses on the belief that, over time, the overall market tends to rise.

Investors essentially ignore the short term fluctuations of the market and invest in stocks with a horizon of many years or decades.

By staying invested, investors benefit from compounding and accumulate significant gains over time.

When combined with the points above, this strategy can result in outperformance.

Many successful investors in India and around the world have used the buy and hold strategy to create generational wealth.

But it's not foolproof.

The strategy assumes that markets will grow over time, which may be true in most cases but even so, is not true for individual stocks.

In the long term, stock returns are decided by company performance which includes industry changes, management decisions, along with the growth of the economy.

The strategy can lead to losses in the case of specific stocks if not monitored regularly.

Remember: Buy and hold does not mean buy and forget.

Before You Look for Long term Stocks

The editorial will help you get started with long-term investing.

But there is something that you should do first: Clean your current portfolio.

Here's how to do that...

• Check your portfolio for any junk stocks. These are companies with high debt, low profits (or losses), and low return ratios. It's best to get rid of these stocks, even at a loss. You will find better stocks for the proceeds.

• Out of the remaining, check to see if the reasons that you bought them are still valid. In some cases, the fundamentals may have deteriorated. In some cases, the growth story may not be playing out as expected. In some cases, corporate governance issues may have come up.

• After selling the stocks that you are not comfortable with is the previous step, check the valuations of the remaining stocks. Some of them may have run up way too much and may be trading at crazy PE ratios, above 100 for example. Consider selling those stocks.

Now you will also have some funds from the proceeds to invest in long term stocks.

Your portfolio would have been trimmed down to a manageable number of high quality stocks with some upside. You can hold on to these.

Some Final Points to Consider

• Ignore all stock tips.

• Do your own research.

• Don't fall victim to fear of missing out (FOMO).

• Stay focused on your investing goals.

• Avoid debt to invest in stocks.

• If you're not a professional trader, then don't trade.

• Don't invest in a way that could negatively affect your sleep.

Conclusion

Investing in stable, fundamentally sound companies can sometimes allow investors to generate outsized returns.

All of this comes from the ability of fundamentally strong companies to weather short-term market volatility. But the key is to do your own research, despite the positive odds. Looking for long-term stocks can serve as a great starting point.

But there is no reason to believe that the long-term winners of the past will remain long-term winners in the future.

So, monitoring their performance, analysing industry trends and studying significant developments is crucial. Avoid it if it's at a high PE ratio.

This will help you stay informed and seize potential investment opportunities at the right price to generate substantial long-term wealth.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...