My usual approach to dealing with investments is to take a proactive approach to both position management and exit strategy. There are many investors however who prefer to take a much more passive approach to their holdings. Value Investing does not necessarily need to be extremely complex or require constant monitoring / action by those who partake in its methods. In this post we’ll look at a method that more passive investors can take towards value investing using a buy & hold mentality.
For the purposes of our discussion today, we’ll define buy & hold to mean forever, i.e. 15+ years. We will use traditional stock valuation strategies to select excellent companies at a price that represents good value. Instead of actively managing the position however, we’ll adopt a buy & hold approach, attempting to accumulate even more every time the stock is undervalued. This may be a more palatable approach for the passive investor who wants to spend a minimal amount of time and effort managing her portfolio, but wants to retain overall control (as opposed to mutual funds for example).
Usually at least once per year there are macroeconomic events that cause the entire stock market to decline. Once or twice per decade there is usually a massive price correction. In these periods of decline the stock prices of great companies can decline 10, 20, or even 30% or more offering investors to buy at a great price. Any number of methods can be used to identify specifically which companies offer the greatest value and focus on those. One example is the EPS Growth Capitalization method. Check out my recent article on Bio-Reference Laboratories (BRLI) to see this valuation method in action.
No matter which valuation method is used, you should end up with a target entry price – in other words the maximum price you are willing to pay for the stock. Some entry strategies such as this one are quite complex in the rules and conditions applied to the purchase of the stock. Once a stock owner, there may be even more rules on how to control position size and eventually exit the stock. Today though, we’re going to look at pure Buy & Hold.
The rules for this strategy are simple:
- Determine how much of your portfolio to allocate to each stock (see my article on Capital Allocation).
- Buy whenever price dips below the target entry price.
- Hold forever.
- Optionally rebalance the portfolio periodically as some stocks become disproportionate in value to the rest of the portfolio
Let’s look at an example and see how this approach might be applied to an investment in Bio-Reference Laboratories (BRLI) over the past year.
We’ll assume that you identified BRLI as a company you believed had excellent long term prospects, and that you want to invest in it for the long term. Rather than buy it outright however, you decide to take a value based approach and only buy when the stock price represented a good discount to the company’s true worth. You have $10,000 to allocate to BRLI at the first available opportunity, and have the ability to save $500 per month for investment in BRLI whenever the value criteria is satisfied. Let’s see how this plays out.
Through the EPS Growth Capitalization method you determine that back in January 2012, a suitable entry price for BRLI was $19 / share. The company was trading at $16.41 on January 3 so you immediately invest the initial $10,000 for a purchase of 600 shares. Price immediately climbs above the target entry price preventing any further purchases for the next few months. On June 1, price again drops below the $19 mark. At $500 savings per month, you have managed to save $2,500 since January. You purchase another 135 shares at $18.50.
Earnings are announced, and you update your target entry price to $22 / share, but alas the lowest that the price drops through the end of 2012 is $24.67 / share. You have managed to save a total of $3,500 through the end of December that is available to invest.
Let’s look at some stats:
- Total amount invested: $9,846 + $2,497 = $12,343
- Total shares purchased: 735
- Cost basis per share: $12,343 / 735 = $16.79 (excluding commissions)
- Current share value: 735 x $28.66 = $21,065 (12/27/12)
- Unutilized funds: $3,657
- Total assets: $24,722
Not bad for the first year. This exact same procedure is carried on going forward indefinitely, for a true Buy & Hold approach.