In my last article, I analyzed the investing rules of SA Superstar Buyandhold 2012. While I commented on the rules he laid out in a recent interview, I did not mention one of his basic rules, the fact that he never sells his stocks, because my article would then become too lengthy. Nevertheless, as I received a comment that suggested analyzing this rule, I will now analyze why I do not recommend following this rule of Buyandhold 2012.
First of all, I have repeatedly emphasized that I have great respect for Buyandhold 2012, as he has an exceptional performance record and always makes interesting comments on SA articles. In addition, his policy of never selling his stocks admittedly has some merits. As the economy and the business of most companies are cyclical, most stocks go through extended bear markets and bull markets. Unfortunately for individual investors, experience has shown that most of them cannot handle the psychological pressure of bear markets and thus tend to sell their stocks during rough times. As a result, they miss the subsequent recovery. That’s why the vast majority of investors, both individuals and professionals, tend to underperform the S&P (NYSEARCA:SPY).
By refusing to sell their stocks, investors have the advantage that they always remain invested and hence they never miss a bull market. As the market spends much more time in an uptrend than in a downtrend, with bull markets lasting 5 times longer than bear markets, the benefit of this strategy is obvious. For instance, those who have remained invested in the S&P for decades are likely to have enjoyed returns around 8.6% per year, as this has been the average annual return of the index since 1960.
On the other hand, investors should keep in mind that a recovery after a bear market is not always guaranteed. To be sure, those who invested in the Japanese stock market in 1989 have not retrieved their losses yet, almost three decades later. Even those who invested in the US stock market before the Great Depression had to wait for more than two decades to break even. And if these two examples are not enough to convince someone that a recovery is not always guaranteed, the major Greek banks, which were “guaranteed” stalwarts until 2009 thanks to their impeccable record, have gone to zero twice since then.
Despite these examples, some investors will claim that the US stock market is not as risky as international markets, as it has swiftly recovered after every single bear market since the Great Depression. While this is true, there is no guarantee that this will continue to be the case forever. In fact, if the US debt, which currently stands at 106% of GDP, keeps growing at the recent pace, it is almost certain that a future recession will last much longer than the previous one and the subsequent recovery may be more anemic than the ongoing one.
One of the fundamental investing rules of Buffett is to never sell a stock at a loss. However, he has repeatedly admitted that investors should sell their stocks at a loss if they realize that their initial thesis was wrong. For instance, when the accounting fraud of Tesco (OTCPK:TSCDF) was revealed, he sold his stake and regretted that he had not sold it earlier. He also sold his stake in Exxon Mobil (XOM) shortly after he initiated it, as he realized that the oil price was just entering a fierce bear market and hence his initial thesis was not valid any more. Therefore, investors should follow the example of the Oracle of Omaha and sell their stocks if they realize that their initial thesis is not valid any more. They should just make their best effort to do their due diligence correctly during the purchase decision in order to avoid the painful experience of selling at a loss later.
Although selling at a loss is very painful, at least to me, I am now glad that I sold my shares of Ensco (ESV) at a 50% loss about two years ago. I had been attracted by the excellent performance of the company when oil was around $100 and the markedly low, single-digit P/E ratio of the stock. Thus I bought the stock at a seemingly cheap level but then the price of oil started to collapse. While I realized that low oil prices were here to stay for years, it was tough to sell my shares and convert the paper losses to real losses, particularly given the magnitude of the losses. Nevertheless, due to the gloomy outlook of off-shore drillers, I decided that my initial thesis was not valid any more and hence I sold the stock.
That move was a game changer for my portfolio. First of all, I saved my portfolio from the continuing meltdown of the stock, which has plunged another 70% since I sold it. Moreover, my portfolio has rallied since then and I have almost reached 3/4 of my retirement goal, at the age of 41. If I had stubbornly held the stock, I would now be in much worse shape. Moreover, investors should always remember that hoping for a turnaround is a devastating strategy unless there is strong tangible evidence for a rebound. If investors keep this rule in mind, they will save themselves from following some stocks down to zero.
It is also worth noting that competition has become stronger than ever in most sectors while technological progress is faster than ever. As a result, the business model of even the most respected company can be disrupted in just a few years and hence it is almost impossible to forecast the future earnings of most companies. Therefore, investors should always evaluate the prospects of their stocks on a regular basis instead of holding them forever and hoping that nothing unfortunate will occur to them. Again, hoping is not a promising long-term investing strategy.
To sum up, while every investor can set his own investing rules based on his mindset, I strongly advise investors to sell their stocks if they realize that their initial thesis is not valid any more. Otherwise, they are likely to follow some stocks down to zero or commit themselves to inferior returns for decades. Buyandhold 2012 is an exceptional investor, with an impressive record; I just disagree with him on this specific rule.
Aristofanis Papadatos
I am a chemical engineer with a MS in Food Technology and Economics. I am also the author of 2 mathematics books ("Arithmetic calculations without a calculator" and "Word Problems") and perform almost all the calculations in my mind, without a calculator, making it easier to make immediate investing decisions among many alternatives. I invest applying fundamental and technical analysis and mainly use options as a tool for both investing and trading. I have nearly achieved my goal of early retirement, at the age of 45. In my spare time, I follow Warren Buffett's principle: "Some men read playboy. I read financial statements".
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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