Question for Stock Buyers

[Hubbs]

So we've had a few stock threads here in the Tailgate, most notably McD5's thread, and in each a variety of posters have demonstrated why "buy and hold" is generally the correct approach. Chief among these posters has been techboy, who has made countless excellent posts full of insight which I would highly recommend to anyone who has even the slightest interest in stock markets.

But I wanted to start a new thread because I have a specific question which needs to be separated from the traditional buy and hold vs. active trading debate. Our current economic climate has often been justifiably compared to Japan's. As most traders know, Japan's Nikkei Index peaked in 1989 and hasn't even come close to those highs since then. Under the specific circumstances Japan has suffered, buy and hold has been a terrible strategy. So if we are, in fact, turning Japanese, what happens to the buy and hold argument?

For the record, here's the Nikkei:

[Skinz4Life12]

not sure if buy and hold is a bad thing right now (thats all i do) but what does everyone think of Starbucks as a long term buy and hold?

[PeterMP]

First, P/E ratio in the Nikkei are traditionally much higher indicating the stocks are of much less value and that is certainly true now. If you think of the world as a world wide market, there is no real reason to believe that in an earnings adjusted manner that Nikkei stocks should be worth more than stocks traded on the NASDAQ or NYSE.

Second, one of techboy's big points when people talks about this is that people over estimate the value of stocks even as a result of the great depression because the price of the stocks is only part of the value of stocks because it doesn't take into account dividends so for the Nikkei, you have to look at the value of the stocks with reinvested dividends not just the absolute value of the stocks (though I do believe the Nikkei stocks tend to pay smaller dividends than the comparable stocks in the US (e.g. the S&P 500 companies pay out more dividends than the Nikkei 250 companies) (thought that's not really surprising when you keep in mind they have inflated P/E ratios)).

[Redskins Diehard]

So we've had a few stock threads here in the Tailgate, most notably McD5's thread, and in each a variety of posters have demonstrated why "buy and hold" is generally the correct approach. Chief among these posters had been techboy, who has made countless excellent posts full of insight which I would highly recommend to anyone who has even the slightest interest in stock markets.

But I wanted to start a new thread because I have a specific question which needs to be separated from the traditional buy and hold vs. active trading debate. Our current economic climate has often been justifiably compared to Japan's. As most traders know, Japan's Nikkei Index peaked in 1989 and hasn't even come close to those highs since then. Under the specific circumstances Japan has suffered, buy and hold has been a terrible strategy. So if we are, in fact, turning Japanese, what happens to the buy and hold argument?

I don't think anything happens to the buy and hold argument.

I have invested every month since May of 95. The shares I bought at the market peak in Oct 2007 have lost about 22%. The ones I bought in Feb 2009 have gained about 35% and we are still at only about 75% of those highs in 07.

Buy and hold generally refers to buying consistently and holding long term. It isn't a guarantee but like Techboy's posts indicate it is better than alternatives in most cases.

[Burgold]

Haven't looked at Starbucks in a long time, but here is my theory. If you think we are in a period of prolonged economic slowdown or unease then Starbucks is not the business I want most. Five bucks for a cup of coffee is a frivolity and as more people worry about their jobs, consider their budgets, or tighten their belts they may just decide that designer coffee needs to go. On top of that, I'm not sure how much more Starbucks can saturate the market. They're going to increase their profitshare one of two ways. In store or expansion. I think both are pretty limited. There are still international markets for Starbucks, I suppose, but an in store growth rate is generally fairly small and I think the ability to open new stores is small because they've opened up so many... and you certainly aren't going to be starting new branches in areas really hit by the economy.

As to the general question, if you think that America is going to head into a huge period of decline, then buy and hold will not work unless you have a twenty year window... and even then some of the companies that were incredible 20 years ago are gone today. Remember Compaq computers? If you think America will rebound and figure things out then buy and hold will do well for you in good and bad times. If you think we are in horrible times, money under the mattress, a shot gun, and a mean dog is best.

[Hubbs]

First, P/E ratio in the Nikkei are traditionally much higher indicating the stocks are of much less value and that is certainly true now. If you think of the world as a world wide market, there is no real reason to believe that in an earnings adjusted manner that Nikkei stocks should be worth more than stocks traded on the NASDAQ or NYSE.

Second, one of techboy's big points when people talks about this is that people over estimate the value of stocks even as a result of the great depression because the price of the stocks is only part of the value of stocks because it doesn't take into account dividends so for the Nikkei, you have to look at the value of the stocks with reinvested dividends not just the absolute value of the stocks (though I do believe the Nikkei stocks tend to pay smaller dividends than the comparable stocks in the US (e.g. the S&P 500 companies pay out more dividends than the Nikkei 250 companies) (thought that's not really surprising when you keep in mind they have inflated P/E ratios)).

1. Right, but that doesn't change the fact that if I bought a lot in 1987, 1988, and 1989 I'm looking at a 50% haircut (albeit without factoring in dividends, but you said those are weaker in Japan anyway).

2. The dividends point is good in general, but you can earn interest with bonds or rent with real estate, so I'm looking primarily at price here.

[Corcaigh]

A few items to consider:

(1) Regular, frequent investing automatically means you buy more shares when prices are low, and fewer when prices are high. Simply due to fluctuations in market price, you make money.

(2) Dividends - even if stock price remains flat, dividends will increase the value of your investment

(3) Diversification - small, medium and large caps, domestic and international, and emerging markets are always of avoiding having all your eggs in one basket.

[Hubbs]

A few items to consider:

(1) Regular, frequent investing automatically means you buy more shares when prices are low, and fewer when prices are high. Simply due to fluctuations in market price, you make money.

(2) Dividends - even if stock price remains flat, dividends will increase the value of your investment

(3) Diversification - small, medium and large caps, domestic and international, and emerging markets are always of avoiding having all your eggs in one basket.

Again, dividends are similar to interest in other investments.

[Corcaigh]

Again, dividends are equivalent to interest in other investments.

Right. So you have the opportunity for income and equity growth.

[Hubbs]

Right. So you have the opportunity for income and equity growth.

Right, and that's why I think techboy has been so good at showing the best way to achieve that equity growth. But I'm specifically asking what he (and others) would change if he felt that the Japanese scenario was likely.

[PeterMP]

1. Right, but that doesn't change the fact that if I bought a lot in 1987, 1988, and 1989 I'm looking at a 50% haircut (albeit without factoring in dividends, but you said those are weaker in Japan anyway).

2. The dividends point is good in general, but you can earn interest with bonds or rent with real estate, so I'm looking primarily at price here.

No, it doesn't, but I'd argue that based on the data you were making a bad investment and that should have been pretty easy to see, especially at the time. The VAST MAJORITY OF THE TIME ANYTHING (including gold and bonds) goes above its long term "corrected" (the correction for different things need to be different) value, you are likely making a bad investment. The P/E ratios of the Nikkei generally told you that there were problems there (and still do today), but ESPECIALLY when they went through the roof, people should have known that it wasn't good because the P/E ratios were becoming even more exaggerted.

Nobody is saying to only invest in stocks. Part of techboys spiel is allocation based on dollars spent. The end result is that when the value of stocks was going through the roof, your allocation results in you are buying fewer stocks, and if other things are going down correspondingly (which frequently happens because people are shifting the investment dollars to X (causing X to go up) from Y (making Y go down)) you are buying more of the thing that is going down.

People that follow techboy advice weren't buying large numbers of Nikkei stocks while the market was at its highest.

Historically, in the US (and most of the world) dividends from stocks have out paced interest from bonds.

[Corcaigh]

Right, and that's why I think techboy has been so good at showing the best way to achieve that equity growth. But I'm specifically asking what he (and others) would change if he felt that the Japanese scenario was likely.

If you think the Japanese situation will be replicated in the USA, then investing a greater amount in international markets would make more sense.

[Hubbs]

No, it doesn't, but I'd argue that based on the data you were making a bad investment and that should have been pretty easy to see, especially at the time. The VAST MAJORITY OF THE TIME ANYTHING (including gold and bonds) goes above its long term "corrected" (the correction for different things need to be different) value, you are likely making a bad investment. The P/E ratios of the Nikkei generally told you that there were problems there (and still do today), but ESPECIALLY when they went through the roof, people should have known that it wasn't good because the P/E ratios were becoming even more exaggerted.

Nobody is saying to only invest in stocks. Part of techboys spiel is allocation based on dollars spent. The end result is that when the value of stocks was going through the roof, your allocation results in you are buying fewer stocks, and if other things are going down correspondingly (which frequently happens because people are shifting the investment dollars to X (causing X to go up) from Y (making Y go down)) you are buying more of the thing that is going down.

People that follow techboy advice weren't buying large numbers of Nikkei stocks while the market was at its highest.

Historically, in the US (and most of the world) dividends from stocks have out paced interest from bonds.

That's a good answer. Thanks. (I'll get back to you in the other thread soon.)

[Hubbs]

If you think the Japanese situation will be replicated in the USA, then investing a greater amount in international markets would make more sense.

That's a good answer, too.

[Skinz4Life12]

my apple stock is on fire this week, too bad i only bought 1 share. sell and reinvest else where or keep holding? this may be a question for McD5 lol

[Redskins Diehard]

my apple stock is on fire this week, too bad i only bought 1 share. sell and reinvest else where or keep holding? this may be a question for McD5 lol

Yes, you would be much better off getting advice from the guy that predicted a sharp fall beginning on Sept 10th or 12th instead of the 2.5% increase since that point. Good luck.

[Burgold]

my apple stock is on fire this week, too bad i only bought 1 share. sell and reinvest else where or keep holding? this may be a question for McD5 lol

I hope you didn't buy one share, by the time you factor in the cost of commissions (the fee charged by your brokerage when you buy and sell) you'll need the stock to rise an insane amount before you can profit from it. I actually made that mistake in my first stock buy Permian Basin. It was an oil company with a yield of about 12% and a PE of about 6. Oil stocks were out of favor and I bought 50 shares of it. I think the buy was around 4 or six dollars. The stock actually jumped by about fifty percent within a few months, but I wound up losing a ton of that just in the broker's cut. Lesson learned.

[Corcaigh]

my apple stock is on fire this week, too bad i only bought 1 share. sell and reinvest else where or keep holding? this may be a question for McD5 lol

How much does it cost you to sell that whole $290 investment? How much of the proceeds will it cost you to buy something else?

[Skinz4Life12]

I hope you didn't buy one share, by the time you factor in the cost of commissions (the fee charged by your brokerage when you buy and sell) you'll need the stock to rise an insane amount before you can profit from it. I actually made that mistake in my first stock buy Permian Basin. It was an oil company with a yield of about 12% and a PE of about 6. Oil stocks were out of favor and I bought 50 shares of it. I think the buy was around 4 or six dollars. The stock actually jumped by about fifty percent within a few months, but I wound up losing a ton of that just in the broker's cut. Lesson learned.

Well the commission is 4.50 and i bought it around 220 a share its up to 290 a share now

[Skinz4Life12]

Yes, you would be much better off getting advice from the guy that predicted a sharp fall beginning on Sept 10th or 12th instead of the 2.5% increase since that point. Good luck.

it was a tongue in cheek comment

[Redskins Diehard]

I hope you didn't buy one share, by the time you factor in the cost of commissions (the fee charged by your brokerage when you buy and sell) you'll need the stock to rise an insane amount before you can profit from it. I actually made that mistake in my first stock buy Permian Basin. It was an oil company with a yield of about 12% and a PE of about 6. Oil stocks were out of favor and I bought 50 shares of it. I think the buy was around 4 or six dollars. The stock actually jumped by about fifty percent within a few months, but I wound up losing a ton of that just in the broker's cut. Lesson learned.

The number of shares does not matter. It is the size of the investment. Not saying I would buy a sharer of Apple. But buying one share of a 290 dollar stock and 290 shares of a 1 dollar stock is the same thing as far as cost goes.

[Burgold]

Well the commission is 4.50 and i bought it around 220 a share its up to 290 a share now

That's okay then. That is a pretty significant rise. Shoulda bought a couple a thousand shares.

And Diehard is kinda right too, though in my mind it's a lot easier to have a ten dollar stock go to 12 then a 100 dollar stock go to 120... though that's an intellectual hiccup on my part that I've never been able to shake.

[techboy]

So if we are, in fact, turning Japanese, what happens to the buy and hold argument?

Absolutely nothing. The research is very clear that market timing is suboptimal. Passive investing in broad, market based indexes is the best approach.

The Japan scenario is scary for equities, of course, but it ignores the following:

1. Mathematically, no matter how bad passive investing in broad based indexes (buy, hold and rebalance) is, the average returns of active investors (market timers) must be worse. This is because all of them put together must have the returns of the market (because that's what the market is), but active management involves much higher costs.

2. You assume that an investor bought everything at the peak, and ignore deflation and dividends. In point of fact, much of an investor's stock portfolio would probably have been purchases both before and after the peak, and dividends would add to that. As an example, it is commonly stated that it took into the 1950s for an investor in the Great Crash of 1929 to be made whole, but even someone that bought at the peak would have broken even after only 4 1/2 years, after including dividends and deflation.

3. A well-balanced portfolio is not just stocks, it includes bonds. I'd also say that it should include a hefty international component (I'm personally at about 60/40 US/international), and some REITs as well (for me, 10%).

In short, there is a risk that we are in a Japan scenario (I'm not sure we are, actually, but the economic argument about that is long and involved and I don't want to bother), and stock investing always includes risk.

However, no matter how bad buy and hold is doing, everything else is even worse.

[Forehead]

Techboy is the smartest investing person I have ever driven with to a Skins game.

[techboy]

2. You assume that an investor bought everything at the peak, and ignore deflation and dividends. In point of fact, much of an investor's stock portfolio would probably have been purchases both before and after the peak, and dividends would add to that. As an example, it is commonly stated that it took into the 1950s for an investor in the Great Crash of 1929 to be made whole, but even someone that bought at the peak would have broken even after only 4 1/2 years, after including dividends and deflation.

To follow up on this, consider this excerpt from Benjamin Graham's classic The Intelligent Investor:

There are no sure and easy paths to riches on Wall Street or anywhere else. It may be well to point up what we have said by a bit of financial history — especially since there is more than one moral to be drawn from it. In the climactic year 1929 John J. Raskob, a most important figure nationally as well as on Wall Street, extolled the blessings of capitalism in an article in the Ladies’ Home Journal, entitled “Everybody Ought to Be Rich.” His thesis was that savings of only $15 per month invested in good common stocks — with dividends reinvested — would produce an estate of $80,000 in twenty years against total contributions of only $3,600. If the General Motors tycoon was right, this was indeed a simple road to riches. How nearly right was he? Our rough calculation — based on assumed investment in the 30 stocks making up the Dow Jones Industrial Average (DJIA) — indicates that if Raskob’s prescription has been followed during 1929-48, the investor’s holdings at the beginning of 1949 would have been worth about $8,500. This is a far cry from the great man’s promise of $80,000, and it shows how little reliance can be placed on such optimistic forecasts and assurances. But, as an aside, we should remark that the return actually realized by the 20-year operation would have been better than 8% compounded annually — and this is despite the fact that the investor would have begun his purchases with the DJIA at 300 and ended with a valuation based on the 1948 closing level of 177. This record may be regarded as a persuasive argument for the principle of regular monthly purchases of strong common stocks through thick and thin — a program known as “dollar cost averaging.”

Emphasis mine.